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LIMESTONE BANCORP, INC. - Quarter Report: 2019 September (Form 10-Q)

lmst20190930_10q.htm
 

 

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2019

 

Or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission file number: 001-33033

 

LIMESTONE BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

  

  

  

Kentucky

  

61-1142247

(State or other jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification No.)

  

  

2500 Eastpoint Parkway, Louisville, Kentucky

  

40223

(Address of principal executive offices)

  

(Zip Code)

 

(502) 499-4800

(Registrant’s telephone number, including area code)

 


Securities registered pursuant to Section 12(b) of the Exchange Act:

 

Title of each class

Trading Symbol(s)

Name of each exchange on which

registered

Common shares

LMST

Nasdaq

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒     No  ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ☐    

Accelerated filer  ☒    

Non-accelerated filer  ☐

Smaller reporting company  ☒

 

Emerging growth company  ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ☐    No  ☒

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

6,251,332 Common Shares and 1,220,000 Non-Voting Common Shares were outstanding at October 31, 2019.

 

 

 

INDEX

 

 

  

  

Page

PART I –

FINANCIAL INFORMATION

  

ITEM 1.

FINANCIAL STATEMENTS

3

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

  32

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

47

ITEM 4.

CONTROLS AND PROCEDURES

47

  

  

  

PART II –

OTHER INFORMATION

  

ITEM 1.

LEGAL PROCEEDINGS

48

ITEM 1A.

RISK FACTORS

48

ITEM 2.

UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS

48

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

48

ITEM 4.

MINE SAFETY DISCLOSURES

48

ITEM 5.

OTHER INFORMATION

48

ITEM 6.

EXHIBITS

49

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

The following consolidated financial statements of Limestone Bancorp, Inc. and subsidiary, Limestone Bank, Inc. are submitted:

 

Unaudited Consolidated Balance Sheets for September 30, 2019 and December 31, 2018

Unaudited Consolidated Statements of Income for the three and nine months ended September 30, 2019 and 2018

Unaudited Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2019 and 2018

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the three and nine months ended September 30, 2019 and 2018

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and 2018

Notes to Unaudited Consolidated Financial Statements

 

 

 

LIMESTONE BANCORP, INC.

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

 

 

   

September 30,

2019

   

December 31,

2018

 

Assets

               

Cash and due from banks

  $ 7,680     $ 6,963  

Interest bearing deposits in banks

    50,327       28,398  

Cash and cash equivalents

    58,007       35,361  

Securities available for sale

    203,381       201,192  

Loans, net of allowance of $8,904 and $8,880, respectively

    794,665       756,364  

Premises and equipment, net

    15,098       14,655  

Premises held for sale

    935       1,050  

Other real estate owned

    3,225       3,485  

Federal Home Loan Bank stock

    6,467       7,233  

Bank owned life insurance

    15,946       15,646  

Deferred taxes, net

    28,029       29,282  

Accrued interest receivable and other assets

    6,411       5,424  

Total assets

  $ 1,132,164     $ 1,069,692  
                 

Liabilities and Stockholders’ Equity

               

Deposits

               

Non-interest bearing

  $ 151,524     $ 142,618  

Interest bearing

    771,910       751,613  

Total deposits

    923,434       894,231  

Federal Home Loan Bank advances

    56,430       46,549  

Accrued interest payable and other liabilities

    4,973       5,815  

Junior subordinated debentures

    21,000       21,000  

Subordinated capital note

    17,000        

Senior debt

    5,000       10,000  

Total liabilities

    1,027,837       977,595  

Commitments and contingent liabilities (Note 13)

           

Stockholders’ equity

               

Common stock, no par, 39,000,000 shares authorized, 6,251,582 and 6,242,720 voting, and 1,220,000 and 1,220,000 non-voting issued and outstanding, respectively

    140,639       140,639  

Additional paid-in capital

    24,328       24,287  

Retained deficit

    (57,447

)

    (66,201

)

Accumulated other comprehensive loss

    (3,193

)

    (6,628

)

Total stockholders' equity

    104,327       92,097  

Total liabilities and stockholders’ equity

  $ 1,132,164     $ 1,069,692  

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Income

(dollars in thousands, except per share data)

 

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2019

   

2018

   

2019

   

2018

 
Interest income                                

Loans, including fees

  $ 10,671     $ 9,539     $ 31,390     $ 27,423  

Taxable securities

    1,553       1,245       4,734       3,386  

Tax exempt securities

    76       95       257       287  

Federal funds sold and other

    185       241       666       624  
      12,485       11,120       37,047       31,720  

Interest expense

                               

Deposits

    3,105       2,130       8,657       5,123  

Federal Home Loan Bank advances

    132       233       668       605  

Senior debt

    77       98       271       292  

Junior subordinated debentures

    251       247       772       694  

Subordinated capital note

    190             190       39  
      3,755       2,708       10,558       6,753  

Net interest income

    8,730       8,412       26,489       24,967  

Provision (negative provision) for loan losses

          (350

)

          (500

)

Net interest income after provision for loan losses

    8,730       8,762       26,489       25,467  
                                 

Non-interest income

                               

Service charges on deposit accounts

    633       608       1,700       1,767  

Bank card interchange fees

    623       411       1,727       1,258  

Income from bank owned life insurance

    97       100       314       337  

Net loss on sales and calls of investment securities

                (5

)

    (6

)

Other

    181       390       528       751  
      1,534       1,509       4,264       4,107  

Non-interest expense

                               

Salaries and employee benefits

    4,202       3,893       12,032       11,566  

Occupancy and equipment

    880       896       2,632       2,671  

Professional fees

    254       186       598       613  

Marketing expense

    251       259       690       867  

FDIC Insurance

          118       211       439  

Data processing expense

    315       281       943       912  

State franchise and deposit tax

    315       282       945       846  

Deposit account related expense

    300       213       891       653  

Other real estate owned expense

    25       271       333       590  

Litigation and loan collection expense

    32       61       112       162  

Other

    877       770       2,569       2,485  
      7,451       7,230       21,956       21,804  

Income before income taxes

    2,813       3,041       8,797       7,770  

Income tax expense

    531       604       43       1,416  

Net income

    2,282       2,437       8,754       6,354  

Basic and diluted income per common share

  $ 0.31     $ 0.33     $ 1.17     $ 0.90  

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Comprehensive Income (Loss)

(in thousands)

                                              

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2019

   

2018

   

2019

   

2018

 

Net income

  $ 2,282     $ 2,437     $ 8,754     $ 6,354  

Other comprehensive income (loss):

                               

Unrealized gain (loss) on securities:

                               

Unrealized gain (loss) arising during the period

    588       (1,006

)

    4,465       (3,234

)

Reclassification adjustment for gains (losses) included in net income

                (5

)

     

Net unrealized gain (loss) recognized in comprehensive income

    588       (1,006

)

    4,470       (3,234

)

Tax effect

    (146

)

    211       (1,035

)

    680  

Other comprehensive income (loss)

    442       (795

)

    3,435       (2,554

)

                                 

Comprehensive income

  $ 2,724     $ 1,642     $ 12,189     $ 3,800  

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Changes in Stockholders’ Equity

For Three and Nine Months Ended September 30, 2019 and 2018

(Dollar amounts in thousands except share and per share data)

 

    Shares     Amount  
    Preferred     Common     Preferred     Common          
   

Series E

   

Series F

   

Common

   

Non-Voting

Common

   

Total

Common

    Series E    

Series F

   

Common and

Non-Voting

Common

   

Additional

Paid-In

Capital

   

Retained Deficit

   

Accumulated

Other

Comprehensive

Income (Loss)

   

Total

 
                                                                                                 

Balances, January 1, 2019

                6,242,720       1,220,000       7,462,720     $     $     $ 140,639     $ 24,287     $ (66,201

)

  $ (6,628

)

  $ 92,097  

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award

                1,642             1,642                         (276

)

                (276

)

Forfeited unvested stock

                (3,748

)

          (3,748

)

                                         

Stock-based compensation expense

                                                    82                   82  

Net income

                                                          2,839             2,839  

Net change in accumulated other comprehensive income, net of taxes

                                                                1,577       1,577  

Balances, March 31, 2019

                6,240,614       1,220,000       7,460,614     $     $     $ 140,639     $ 24,093     $ (63,362

)

  $ (5,051

)

  $ 96,319  

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award

                (2,532

)

          (2,532

)

                      (39

)

                (39

)

Forfeited unvested stock

                (250

)

          (250

)

                                         

Stock-based compensation expense

                                                    93                   93  

Net income

                                                          3,633             3,633  

Net change in accumulated other comprehensive income, net of taxes

                                                                1,416       1,416  

Balances, June 30, 2019

                6,237,832       1,220,000       7,457,832     $     $     $ 140,639     $ 24,147     $ (59,729

)

  $ (3,635

)

  $ 101,422  

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award

                13,750             13,750                                            

Forfeited unvested stock

                                                                       

Stock-based compensation expense

                                                    181                   181  

Net income

                                                          2,282             2,282  

Net change in accumulated other comprehensive income, net of taxes

                                                                442       442  

Balances, September 30, 2019

                6,251,582       1,220,000       7,471,582     $     $     $ 140,639     $ 24,328     $ (57,447

)

  $ (3,193

)

  $ 104,327  

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Changes in Stockholders’ Equity

For Three and Nine Months Ended September 30, 2019 and 2018

(Dollar amounts in thousands except share and per share data)

 

    Shares     Amount  
    Preferred     Common     Preferred     Common          
   

Series E

   

Series F

   

Common

   

Non-Voting

Common

   

Total

Common

   

Series E

   

Series F

   

Common and

Non-Voting

Common

   

Additional

Paid-In Capital

   

Retained Deficit

   

Accumulated

Other

Comprehensive

Income (Loss)

   

Total

 
                                                                                                 

Balances, January 1, 2018

    6,198       4,304       6,039,864       220,000       6,259,864     $ 1,644     $ 1,127     $ 125,729     $ 24,497     $ (75,108

)

  $ (5,216

)

  $ 72,673  

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award

                                                                       

Forfeited unvested stock

                                                                       

Issuance of stock

                150,000       1,000,000       1,150,000                   14,910                         14,910  

Stock-based compensation expense

                                                    64                   64  

Net income

                                                          1,934             1,934  

Reclassification of disproportionate tax effect due to change in federal tax rate

                                                          113       (113

)

     

Net change in accumulated other comprehensive income, net of taxes

                                                                (1,351

)

    (1,351

)

Balances, March 31, 2018

    6,198       4,304       6,189,864       1,220,000       7,409,864     $ 1,644     $ 1,127     $ 140,639     $ 24,561     $ (73,061

)

  $ (6,680

)

  $ 88,230  

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award

                45,129             45,129                                            

Forfeited unvested stock

                                                                       

Redemption and retirement of preferred shares

    (6,198

)

    (4,304

)

                      (1,644

)

    (1,127

)

          (734

)

                (3,505

)

Stock-based compensation expense

                                                    99                   99  

Net income

                                                          1,983             1,983  

Net change in accumulated other comprehensive income, net of taxes

                                                                (408

)

    (408

)

Balances, June 30, 2018

                6,234,993       1,220,000       7,454,993     $     $     $ 140,639     $ 23,926     $ (71,078

)

  $ (7,088

)

  $ 86,399  

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award

                1,597             1,597                                            

Forfeited unvested stock

                                                                       

Redemption and retirement of preferred shares

                                                                       

Stock-based compensation expense

                                                    171                   171  

Net income

                                                          2,437             2,437  

Net change in accumulated other comprehensive income, net of taxes

                                                                (795

)

    (795

)

Balances, September 30, 2018

                6,236,590       1,220,000       7,456,590     $     $     $ 140,639     $ 24,097     $ (68,641

)

  $ (7,883

)

  $ 88,212  

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Cash Flows

For Nine Months Ended September 30, 2019 and 2018

(dollars in thousands)

 

   

2019

   

2018

 

Cash flows from operating activities

               

Net income

  $ 8,754     $ 6,354  

Adjustments to reconcile net income to net cash from operating activities

               

Depreciation and amortization

    1,310       739  

Provision (negative provision) for loan losses

          (500

)

Net amortization on securities

    530       669  

Stock-based compensation expense

    356       334  

Deferred taxes, net

    215       1,762  

Net gain on sales of loans held for sale

          (1

)

Proceeds from sales of loans held for sale

          71  

Net gain on sales of other real estate owned

          (72

)

Net write-down of other real estate owned

    260       585  

Net gain on sales of premises and equipment

    (1

)

    (46

)

Net realized loss on sales and calls of investment securities

    5       6  

Net write-down on premises held for sale

    115        

Earnings on bank owned life insurance, net of premium expense

    (300

)

    (322

)

Net change in accrued interest receivable and other assets

    (987

)

    (950

)

Net change in accrued interest payable and other liabilities

    (1,165

)

    (395

)

Net cash from operating activities

    9,092       8,234  
                 

Cash flows from investing activities

               

Purchases of available for sale securities

    (14,894

)

    (58,965

)

Sales and calls of available for sale securities

    3,452       6,054  

Maturities and prepayments of available for sale securities

    13,190       16,852  

Proceeds from mandatory redemptions of FHLB stock

    766       90  

Proceeds from sale of other real estate owned

          876  

Loan originations and payments, net

    (38,986

)

    (44,823

)

Purchases of premises and equipment, net

    (744

)

    (982

)

Proceeds from sale of premises and equipment

    1       141  

Net cash from investing activities

    (37,215

)

    (80,757

)

                 

Cash flows from financing activities

               

Net change in deposits

    29,203       27,002  

Repayment of Federal Home Loan Bank advances

    (105,119

)

    (85,206

)

Advances from Federal Home Loan Bank

    115,000       125,000  

Repayment of subordinated capital note

          (2,250

)

Proceeds from issuance of subordinated capital note

    17,000        

Repayment of senior debt

    (5,000

)

     

Issuance of common stock

          14,910  

Common shares withheld for taxes

    (315

)

     

Redemption of preferred stock

          (3,505

)

Net cash from financing activities

    50,769       75,951  

Net change in cash and cash equivalents

    22,646       3,428  

Beginning cash and cash equivalents

    35,361       34,103  

Ending cash and cash equivalents

  $ 58,007     $ 37,531  
                 

Supplemental cash flow information:

               

Interest paid

  $ 10,364     $ 7,631  

Supplemental non-cash disclosure:

               

Transfer from loans to other real estate

          730  

Initial recognition of right-of-use lease assets

    507        

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

LIMESTONE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

 

 

 

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Presentation – The consolidated financial statements include Limestone Bancorp, Inc. (Company) and its subsidiary, Limestone Bank (Bank). The Company owns a 100% interest in the Bank. All significant inter-company transactions and accounts have been eliminated in consolidation.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the entire year. A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2018 included in the Company’s Annual Report on Form 10-K.

 

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.

 

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation. The reclassifications did not impact net income or stockholders’ equity.

 

New Accounting Standards In February 2016, the FASB issued an update ASU No. 2016-02, Leases (Topic 842). Under the new guidance, lessees are required to recognize the following for all leases, with the exception of short-term leases, at the commencement date: a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. The amendments in this update became effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. Based on the Company’s existing lease agreements, the impact of adopting the new guidance on the consolidated financial statements was the recording of a $507,000 lease liability and a right of use asset, which is included in other liabilities and premises and equipment, respectively, on the consolidated balance sheet. The adoption of this ASU did not have a meaningful impact on the Company’s performance metrics, including regulatory capital ratios and return on average assets. The Company’s leases mature through 2024 and have a weighted average discount rate of 6%. The operating lease cost was approximately $65,000 and $195,000 for the three and nine months ended September 30, 2019. At September 30, 2019, the Company had entered into one lease that has yet to commence. The right of use asset and lease liability for the lease yet to commence are estimated to be approximately $1.1 million and are expected to be recorded in the fourth quarter of 2019.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The final standard will change estimates for credit losses related to financial assets measured at amortized cost such as loans, held-to-maturity debt securities, and certain other contracts. For estimating credit losses, the FASB is replacing the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (CECL) model. Under the CECL model, certain financial assets that are carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, are required to be presented at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current GAAP, which delays recognition until it is probable a loss has been incurred. The change could materially affect how the allowance for loan losses is determined. The impact of CECL model implementation is being evaluated, but it is expected that a one-time cumulative-effect adjustment to the allowance for loan losses will be recognized in retained earnings on the consolidated balance sheet as of the beginning of the first reporting period in which the new standard is effective, as is consistent with regulatory expectations set forth in interagency guidance. In December 2018, the OCC, The Board of Governors of the Federal Reserve System, and the FDIC approved a final rule to address changes to the credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from adoption of the new accounting standard. In October 2019, the FASB voted to delay implementation for smaller reporting companies, private companies, and not-for-profit entities. The Company currently qualifies as a smaller reporting company. Companies qualifying for the delay will be required to implement CECL for fiscal year and interim periods beginning after December 15, 2022.

 

 

In March 2017, the FASB issued ASU No. 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization of Purchased Callable Debt Securities. The final standard will shorten the amortization period for premiums on callable debt securities by requiring that premiums be amortized to the first (or earliest) call date instead of as an adjustment to the yield over the contractual life. The standard was effective for public companies for fiscal years beginning after December 15, 2018. Adoption of this new guidance did not have a material impact on the consolidated financial statements.

 

 

Note 2 – Securities

 

Securities are classified as available for sale (AFS). AFS securities may be sold if needed for liquidity, asset liability management, or other reasons. AFS securities are reported at fair value, with unrealized gains or losses included as a separate component of equity, net of tax.

 

The amortized cost and fair value of securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

 

   

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair Value

 
   

(in thousands)

 
September 30, 2019                                

Available for sale

                               

U.S. Government and federal agency

  $ 22,674     $ 317     $ (56

)

  $ 22,935  

Agency mortgage-backed: residential

    88,884       1,387       (169

)

    90,102  

Collateralized loan obligations

    49,851       5       (260

)

    49,596  

State and municipal

    29,026       609       (2

)

    29,633  

Corporate bonds

    10,926       189             11,115  

Total available for sale

  $ 201,361     $ 2,507     $ (487

)

  $ 203,381  

 

December 31, 2018

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair Value

 

Available for sale

                               

U.S. Government and federal agency

  $ 23,280     $ 2     $ (722

)

  $ 22,560  

Agency mortgage-backed: residential

    87,689       192       (1,891

)

    85,990  

Collateralized loan obligations

    49,942             (103

)

    49,839  

State and municipal

    32,841       230       (259

)

    32,812  

Corporate bonds

    9,890       127       (26

)

    9,991  

Total available for sale

  $ 203,642     $ 551     $ (3,001

)

  $ 201,192  

 

 

Sales and calls of securities were as follows:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2019

   

2018

   

2019

   

2018

 
    (in thousands)     (in thousands)  

Proceeds

  $ 1,000     $     $ 3,452     $ 6,054  

Gross gains

                1        

Gross losses

                6       6  

 

 

The amortized cost and fair value of our debt securities are shown by contractual maturity. Expected maturities may differ from actual maturities when borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities not due at a single maturity date are shown separately. 

 

   

September 30, 2019

 
   

Amortized

Cost

   

Fair

Value

 
   

(in thousands)

 

Maturity

               

Available for sale

               

Within one year

  $ 47,700     $ 47,548  

One to five years

    37,548       38,168  

Five to ten years

    26,229       26,563  

Beyond ten years

    1,000       1,000  

Agency mortgage-backed: residential

    88,884       90,102  

Total

  $ 201,361     $ 203,381  

 

                                                                                              

Securities pledged at September 30, 2019 and December 31, 2018 had carrying values of approximately $74.6 million and $64.4 million, respectively, and were pledged to secure public deposits.

 

At September 30, 2019 and December 31, 2018, the Bank held securities issued by the Commonwealth of Kentucky or Kentucky municipalities having a book value of $14.7 million and $15.3 million, respectively. At September 30, 2019 and December 31, 2018, there were no other holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

 

The Bank owns Collateralized Loan Obligations (CLOs), which are debt securities secured by professionally managed portfolios of senior-secured loans to corporations. CLO managers are typically large non-bank financial institutions or banks and are typically $300 million to $1 billion in size, contain one hundred or more loans, have five to six credit tranches ranging from AAA, AA, A, BBB, BB, B and equity tranche. Interest and principal are paid first to the AAA tranche then to the next lower rated tranche. Losses are borne first by the equity tranche then by the subsequently higher rated tranche. CLOs may be less liquid than government securities from time to time and volatility in the CLO market may cause the value of these investments to decline.

 

The market value of CLOs may be affected by, among other things, changes in composition of the underlying loans, changes in the cash flows from the underlying loans, defaults and recoveries on the underlying loans, capital gains and losses on the underlying loans, and prepayments on the underlying loans.

 

At September 30, 2019, $33.0 million and $16.6 million of our CLOs were AA and A rated, respectively. There were no CLOs rated below A and none of the CLOs were subject to ratings downgrade in the nine months ended September 30, 2019. All of the Bank’s CLOs are floating rate, with rates set on a quarterly basis at three-month LIBOR plus a spread.

 

The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition. As of September 30, 2019, management does not believe any securities in the portfolio with unrealized losses should be classified as other than temporarily impaired.

 

 

Securities with unrealized losses at September 30, 2019 and December 31, 2018, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, are as follows:

 

 

   

Less than 12 Months

   

12 Months or More

   

Total

 

Description of Securities

 

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

 
   

(in thousands)

 

September 30, 2019

                                               

Available for sale

                                               

U.S. Government and federal agency

  $ 9,128     $ (56

)

  $     $     $ 9,128     $ (56

)

Agency mortgage-backed: residential

    11,701       (34

)

    12,315       (135

)

    24,016       (169

)

Collateralized loan obligations

    19,893       (178

)

    15,568       (82

)

    35,461       (260

)

State and municipal

                934       (2

)

    934       (2

)

Corporate bonds

                                   

Total temporarily impaired

  $ 40,722     $ (268

)

  $ 28,817     $ (219

)

  $ 69,539     $ (487

)

                                                 
                                                 

December 31, 2018

                                               

Available for sale

                                               

U.S. Government and federal agency

  $ 3,431     $ (57

)

  $ 17,212     $ (665

)

  $ 20,643     $ (722

)

Agency mortgage-backed: residential

    30,229       (343

)

    40,932       (1,548

)

    71,161       (1,891

)

Collateralized loan obligations

    48,294       (103

)

                48,294       (103

)

State and municipal

    6,133       (29

)

    7,252       (230

)

    13,385       (259

)

Corporate Bonds

    3,569       (26

)

                3,569       (26

)

Total temporarily impaired

  $ 91,656     $ (558

)

  $ 65,396     $ (2,443

)

  $ 157,052     $ (3,001

)

 

 

Note 3 – Loans

 

Loans net of unearned income, deferred loan origination costs, and net premiums on acquired loans by class were as follows:

 

   

September 30,

   

December 31,

 
   

2019

   

2018

 
   

(in thousands)

 

Commercial

  $ 135,981     $ 129,368  

Commercial Real Estate:

               

Construction

    66,351       86,867  

Farmland

    82,593       77,937  

Nonfarm nonresidential

    194,660       172,177  

Residential Real Estate:

               

Multi-family

    59,385       49,757  

1-4 Family

    166,412       175,761  

Consumer

    52,347       39,104  

Agriculture

    45,357       33,737  

Other

    483       536  

Subtotal

    803,569       765,244  

Less: Allowance for loan losses

    (8,904

)

    (8,880

)

Loans, net

  $ 794,665     $ 756,364  

 

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2019 and 2018:

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

September 30, 2019:

                                                       

Beginning balance

  $ 1,492     $ 4,453     $ 2,327     $ 153     $ 405     $ 2     $ 8,832  

Provision (negative provision)

    (68

)

    341       (686

)

    354       60       (1

)

     

Loans charged off

    (10

)

    (32

)

    (73

)

    (184

)

                (299

)

Recoveries

    6       7       345       9       3       1       371  

Ending balance

  $ 1,420     $ 4,769     $ 1,913     $ 332     $ 468     $ 2     $ 8,904  
                                                         
                                                         

September 30, 2018:

                                                       

Beginning balance

  $ 1,133     $ 4,234     $ 2,778     $ 66     $ 367     $ 2     $ 8,580  

Provision (negative provision)

    65       (48

)

    (393

)

    21       5             (350

)

Loans charged off

    (50

)

          (78

)

    (15

)

                (143

)

Recoveries

    10       295       231       9       2             547  

Ending balance

  $ 1,158     $ 4,481     $ 2,538     $ 81     $ 374     $ 2     $ 8,634  

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2019 and 2018: 

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

September 30, 2019:

                                                       

Beginning balance

  $ 1,299     $ 4,676     $ 2,452     $ 130     $ 321     $ 2     $ 8,880  

Provision (negative provision)

    30       130       (838

)

    531       148       (1

)

     

Loans charged off

    (10

)

    (47

)

    (190

)

    (398

)

    (4

)

          (649

)

Recoveries

    101       10       489       69       3       1       673  

Ending balance

  $ 1,420     $ 4,769     $ 1,913     $ 332     $ 468     $ 2     $ 8,904  
                                                         
                                                         

September 30, 2018:

                                                       

Beginning balance

  $ 892     $ 4,032     $ 2,900     $ 64     $ 313     $ 1     $ 8,202  

Provision (negative provision)

    61       (68

)

    (557

)

    7       60       (3

)

    (500

)

Loans charged off

    (50

)

    (198

)

    (166

)

    (49

)

    (12

)

    (8

)

    (483

)

Recoveries

    255       715       361       59       13       12       1,415  

Ending balance

  $ 1,158     $ 4,481     $ 2,538     $ 81     $ 374     $ 2     $ 8,634  

 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of September 30, 2019:

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

Allowance for loan losses:

                                                       

Ending allowance balance attributable to loans:

                                                       

Individually evaluated for impairment

  $ 1     $ 32     $     $     $     $     $ 33  

Collectively evaluated for impairment

    1,419       4,737       1,913       332       468       2       8,871  

Total ending allowance balance

  $ 1,420     $ 4,769     $ 1,913     $ 332     $ 468     $ 2     $ 8,904  
                                                         

Loans:

                                                       

Loans individually evaluated for impairment

  $ 75     $ 723     $ 1,739     $ 153     $ 65     $     $ 2,755  

Loans collectively evaluated for impairment

    135,906       342,881       224,058       52,194       45,292       483       800,814  

Total ending loans balance

  $ 135,981     $ 343,604     $ 225,797     $ 52,347     $ 45,357     $ 483     $ 803,569  

 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2018:

 

 

   

Commercial

   

Commercial

Real Estate

   

Residential

Real Estate

   

Consumer

   

Agriculture

   

Other

   

Total

 
   

(in thousands)

 

Allowance for loan losses:

                                                       

Ending allowance balance attributable to loans:

                                                       

Individually evaluated for impairment

  $     $ 35     $ 168     $     $     $     $ 203  

Collectively evaluated for impairment

    1,299       4,641       2,284       130       321       2       8,677  

Total ending allowance balance

  $ 1,299     $ 4,676     $ 2,452     $ 130     $ 321     $ 2     $ 8,880  
                                                         
                                                         

 

Loans:

                                                       

Loans individually evaluated for impairment

  $ 53     $ 510     $ 2,348     $     $     $     $ 2,911  

Loans collectively evaluated for impairment

    129,315       336,471       223,170       39,104       33,737       536       762,333  

Total ending loans balance

  $ 129,368     $ 336,981     $ 225,518     $ 39,104     $ 33,737     $ 536     $ 765,244  

 

Impaired Loans

 

Impaired loans include restructured loans and loans on nonaccrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss has been provided.

 

 

The following tables present information related to loans individually evaluated for impairment by class of loans as of September 30, 2019 and December 31, 2018 and for the three and nine months ended September 30, 2019 and 2018:

 

   

As of September 30, 2019

   

Three Months Ended

September 30, 2019

   

Nine Months Ended

September 30, 2019

 
   

Unpaid

Principal

Balance

   

Recorded

Investment

   

Allowance

For Loan

Losses

Allocated

   

Average

Recorded

Investment

   

Interest

Income

Recognized

   

 

Average

Recorded

Investment

   

 

Interest

Income

Recognized

 
   

(in thousands)

 

With No Related Allowance Recorded:

                                                       

Commercial

  $ 138     $ 50     $     $ 66     $ 2     $ 59     $ 2  

Commercial real estate:

                                                       

Construction

                                         

Farmland

    340       198             202       2       150       10  

Nonfarm nonresidential

    689       234             237       2       247       9  

Residential real estate:

                                                       

Multi-family

                                         

1-4 Family

    2,641       1,739             1,588       132       1,566       182  

Consumer

    332       153             76       2       45       4  

Agriculture

    65       65             65             49        

Other

                                         

Subtotal

    4,205       2,439             2,234       140       2,116       207  

With An Allowance Recorded:

                                                       

Commercial

    25       25       1       26       1       13       2  

Commercial real estate:

                                                       

Construction

                                         

Farmland

    291       291       32       292       7       225       7  

Nonfarm nonresidential

                                         

Residential real estate:

                                                       

Multi-family

                                         

1-4 Family

                      356       7       537       28  

Consumer

                                         

Agriculture

                                         

Other

                                         

Subtotal

    316       316       33       674       15       775       37  

Total

  $ 4,521     $ 2,755     $ 33     $ 2,908     $ 155     $ 2,891     $ 244  

 

   

As of December 31, 2018

   

Three Months Ended

September 30, 2018

   

Nine Months Ended

September 30, 2018

 
   

Unpaid

Principal

Balance

   

Recorded

Investment

   

Allowance

For Loan

Losses

Allocated

   

Average

Recorded

Investment

   

Interest

Income

Recognized

   

 

Average

Recorded

Investment

   

 

Interest

Income

Recognized

 
   

(in thousands)

 

With No Related Allowance Recorded:

                                                       

Commercial

  $ 120     $ 53     $     $ 33     $     $ 143     $ 1  

Commercial real estate:

                                                       

Construction

                                         

Farmland

    1,860       89             974       27       1,423       308  

Nonfarm nonresidential

    402       262             259       11       343       19  

Residential real estate:

                                                       

Multi-family

                                         

1-4 Family

    2,678       1,628             1,591       116       2,048       151  

Consumer

    12                               1        

Agriculture

                                         

Other

                                         

Subtotal

    5,072       2,032             2,857       154       3,958       479  

With An Allowance Recorded:

                                                       

Commercial

                      50             75       4  

Commercial real estate:

                                                       

Construction

                                         

Farmland

                      171             86        

Nonfarm nonresidential

    159       159       35                          

Residential real estate:

                                                       

Multi-family

                                         

1-4 Family

    720       720       168       1,102             1,208       32  

Consumer

                                         

Agriculture

                                         

Other

                                         

Subtotal

    879       879       203       1,323             1,369       36  

Total

  $ 5,951     $ 2,911     $ 203     $ 4,180     $ 154     $ 5,327     $ 515  

 

 

Cash basis income recognized for the three and nine months ended September 30, 2019 was $137,000 and $197,000, respectively, compared to $93,000 and $410,000 for the three and nine months ended September 30, 2018, respectively.

 

Troubled Debt Restructuring

 

A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The Bank’s TDRs may involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower.

 

The following table presents the types of TDR loan modifications by portfolio segment outstanding as of September 30, 2019 and December 31, 2018:

 

   

TDRs

Performing to

Modified Terms

   

TDRs Not

Performing to

Modified Terms

   

Total

TDRs

 
   

(in thousands)

 

September 30, 2019

                       

Commercial Real Estate:

                       

Nonfarm nonresidential

                       

Rate reduction

  $ 188           $ 188  

Total TDRs

  $ 188     $     $ 188  

 

 

   

TDRs

Performing to

Modified Terms

   

TDRs Not

Performing to

Modified Terms

   

Total

TDRs

 
   

(in thousands)

 

December 31, 2018

                       

Commercial Real Estate:

                       

Nonfarm nonresidential

                       

Rate reduction

  $ 190     $     $ 190  

Residential Real Estate:

                       

1-4 Family

                       

Rate reduction

    720             720  

Total TDRs

  $ 910     $     $ 910  

 

At September 30, 2019 and December 31, 2018, 100% of the Company’s TDRs were performing according to their modified terms. There were no allocated reserves and $168,000 in reserves to borrowers whose loan terms have been modified in TDRs as of September 30, 2019, and December 31, 2018, respectively. The Company has committed to lend no additional amounts as of September 30, 2019 and December 31, 2018 to borrowers with outstanding loans classified as TDRs.

 

No TDR loan modifications occurred during the three or nine months ended September 30, 2019 or September 30, 2018. During the first nine months of 2019 and 2018, no TDRs defaulted on their restructured loan within the 12-month period following the loan modification. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.

 

 

Non-performing Loans

 

Non-performing loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment. The following table presents the recorded investment in nonaccrual and loans past due 90 days and still on accrual by class of loan as of September 30, 2019, and December 31, 2018: 

 

 

   

Nonaccrual

   

Loans Past Due 90 Days

And Over Still Accruing

 
   

September

30,

2019

   

December

31,

2018

   

September

30,

2019

   

December

31,

2018

 
   

(in thousands)

 
                                 

Commercial

  $ 50     $ 53     $     $  

Commercial Real Estate:

                               

Construction

                       

Farmland

    337       249              

Nonfarm nonresidential

    46       61              

Residential Real Estate:

                               

Multi-family

                       

1-4 Family

    1,739       1,628              

Consumer

    152                    

Agriculture

    65                    

Other

                       

Total

  $ 2,389     $ 1,991     $     $  

 

 

The following table presents the aging of the recorded investment in past due loans as of September 30, 2019 and December 31, 2018:

 

 

   

30 – 59

Days

Past Due

   

60 – 89

Days

Past Due

   

90 Days

And Over

Past Due

   

 

 

Nonaccrual

   

Total

Past Due

And

Nonaccrual

 
   

(in thousands)

 

September 30, 2019

                                       

Commercial

  $ 27     $     $     $ 50     $ 77  

Commercial Real Estate:

                                       

Construction

                             

Farmland

    244                   337       581  

Nonfarm nonresidential

                      46       46  

Residential Real Estate:

                                       

Multi-family

                             

1-4 Family

    541       92             1,739       2,372  

Consumer

    167       70             152       389  

Agriculture

          395             65       460  

Other

                             

Total

  $ 979     $ 557     $     $ 2,389     $ 3,925  

 

 

   

30 – 59

Days

Past Due

   

60 – 89

Days

Past Due

   

90 Days

And Over

Past Due

   

 

 

Nonaccrual

   

Total

Past Due

And

Nonaccrual

 
                                         
   

(in thousands)

 

December 31, 2018

                                       

Commercial

  $ 39     $     $     $ 53     $ 92  

Commercial Real Estate:

                                       

Construction

                             

Farmland

    244       107             249       600  

Nonfarm nonresidential

          52             61       113  

Residential Real Estate:

                                       

Multi-family

                             

1-4 Family

    1,299       137             1,628       3,064  

Consumer

    8       35                   43  

Agriculture

    3                         3  

Other

                             

Total

  $ 1,593     $ 331     $     $ 1,991     $ 3,915  

 

Credit Quality Indicators 

 

Management categorizes all loans into risk categories at origination based upon original underwriting. Thereafter, management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends. Additionally, loans are analyzed through internal and external loan review processes. Borrower relationships in excess of $500,000 are routinely analyzed through credit administration processes which classify the loans as to credit risk. The following definitions are used for risk ratings:

 

Watch – Loans classified as watch are those loans which have or may experience a potentially adverse development which necessitates increased monitoring.

 

Special Mention – Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.

 

Substandard – Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

 

Doubtful – Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.

 

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans. As of September 30, 2019, and December 31, 2018, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

   

Pass

   

Watch

   

Special

Mention

   

Substandard

   

Doubtful

   

Total

 
   

(in thousands)

 

September 30, 2019

                                               

Commercial

  $ 120,205     $ 11,461     $     $ 4,315     $     $ 135,981  

Commercial Real Estate:

                                               

Construction

    66,351                               66,351  

Farmland

    74,830       6,773             990             82,593  

Nonfarm nonresidential

    184,052       8,147             2,461             194,660  

Residential Real Estate:

                                               

Multi-family

    59,385                               59,385  

1-4 Family

    160,978       1,882             3,552             166,412  

Consumer

    52,124       20             203             52,347  

Agriculture

    35,642       9,254             461             45,357  

Other

    483                               483  

Total

  $ 754,050     $ 37,537     $     $ 11,982     $     $ 803,569  

 

   

Pass

   

Watch

   

Special

Mention

   

Substandard

   

Doubtful

   

Total

 
   

(in thousands)

 

December 31, 2018

                                               

Commercial

  $ 129,106     $ 141     $     $ 121     $     $ 129,368  

Commercial Real Estate:

                                               

Construction

    86,867                               86,867  

Farmland

    74,054       2,741             1,142             77,937  

Nonfarm nonresidential

    169,551       1,983             643             172,177  

Residential Real Estate:

                                               

Multi-family

    44,697       5,060                         49,757  

1-4 Family

    169,342       2,209       113       4,097             175,761  

Consumer

    38,768       11             325             39,104  

Agriculture

    32,683       1,019             35             33,737  

Other

    536                               536  

Total

  $ 745,604     $ 13,164     $ 113     $ 6,363     $     $ 765,244  

 

 

Note 4 – Other Real Estate Owned

 

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less estimated cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses.

 

Fair value of OREO is determined on an individual property basis. When foreclosed properties are acquired, management obtains a new appraisal of the subject property or has staff from the Bank’s special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Updated appraisals are typically obtained within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a marketing price is lowered below the appraised amount. 

 

The following table presents the major categories of OREO at the period-ends indicated: 

 

   

September 30,

2019

   

December 31,

2018

 
   

(in thousands)

 

Commercial Real Estate:

               

Construction, land development, and other land

  $ 3,225     $ 3,485  
    $ 3,225     $ 3,485  

 

Residential loans secured by 1-4 family residential properties in the process of foreclosure totaled $199,000 and $771,000 at September 30, 2019 and December 31, 2018, respectively.

 

 

Activity relating to OREO during the nine months ended September 30, 2019 and 2018 is as follows:

 

   

For the Nine

Months Ended

September 30,

 
   

2019

   

2018

 
   

(in thousands)

 

OREO Activity

               

OREO as of January 1

  $ 3,485     $ 4,409  

Real estate acquired

          730  

Valuation adjustment write-downs

    (260

)

    (585

)

Net gain on sales

          72  

Proceeds from sales of properties

          (876

)

OREO as of September 30

  $ 3,225     $ 3,750  

 

 

Expenses related to other real estate owned include:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

(in thousands) (in thousands)

 

Net gain on sales

  $     $ (22

)

  $     $ (72

)

Valuation adjustment write-downs

          260       260       585  

Operating expense

    25       33       73       77  

Total

  $ 25     $ 271     $ 333     $ 590  

 

 

Note 5 – Deposits

 

The following table details deposits by category:

 

 

   

September 30,

2019

   

December 31,

2018

 
   

(in thousands)

 

Non-interest bearing

  $ 151,524     $ 142,618  

Interest checking

    95,508       94,269  

Money market

    153,663       171,924  

Savings

    34,618       34,534  

Certificates of deposit

    488,121       450,886  

Total

  $ 923,434     $ 894,231  

 

Time deposits of $250,000 or more were $27.6 million and $28.1 million at September 30, 2019 and December 31, 2018, respectively.

 

Scheduled maturities of total time deposits at September 30, 2019 for each of the next five years and thereafter are as follows (in thousands):

 

Year 1

  $ 432,275  

Year 2

    29,073  

Year 3

    6,078  

Year 4

    9,504  

Year 5

    10,875  

Thereafter

    316  
    $ 488,121  

 

 

 

Note 6 – Advances from the Federal Home Loan Bank

 

Advances from the Federal Home Loan Bank were as follows:

 

   

September 30,

   

December 31,

 
   

2019

   

2018

 
   

(in thousands)

 
                 

Short term advances (fixed rates 2.03% to 2.11%) maturing October 2019

  $ 55,000     $ 45,000  

Long term advances (fixed rates 0.00% to 5.24%) maturing April 2020 to August 2033

    1,430       1,549  

Total advances from the Federal Home Loan Bank

  $ 56,430     $ 46,549  

 

FHLB advances had a weighted-average rate of 2.05% at September 30, 2019 and 2.45% at December 31, 2018. Each advance is payable per terms on agreement, with a prepayment penalty. No prepayment penalties were incurred during 2019 or 2018. The advances were collateralized by approximately $123.9 million and $130.4 million of first mortgage loans, under a blanket lien arrangement at September 30, 2019 and December 31, 2018, respectively. At September 30, 2019, our additional borrowing capacity with the FHLB was $30.7 million.

 

Scheduled principal payments on the above during the next five years and thereafter (in thousands):

 

   

Advances

 

Year 1

  $ 55,490  

Year 2

    728  

Year 3

    99  

Year 4

    77  

Year 5

    26  

Thereafter

    10  
    $ 56,430  

 

 

 

Note 7 – Borrowings

 

Junior Subordinated Debentures – The junior subordinated debentures are redeemable at par prior to maturity at the option of the Company as defined within the trust indenture. The Company has the option to defer interest payments on the junior subordinated debentures from time to time for a period not to exceed 20 consecutive quarters. A deferral period may begin at the Company’s discretion so long as interest payments are current. The Company is prohibited from paying dividends on preferred and common shares when interest payments are in deferral. At September 30, 2019, the Company is current on all interest payments.

 

Subordinated Capital Note – On July 23, 2019, the Company completed the issuance of a 10-year subordinated note for $17.0 million. The note carries interest at a fixed rate of 5.75% for the first five years and qualifies as Tier 2 regulatory capital. The Company contributed $10.0 million of the proceeds to the Bank as Tier 1 capital, used $5.0 million to reduce senior debt, and retained the remaining proceeds for general corporate purposes.

 

Senior Debt - The Company’s $5.0 million senior secured loan matures on June 30, 2022. Interest is payable quarterly at a rate of three-month LIBOR plus 250 basis points through June 30, 2020, at which time quarterly principal payments of $250,000 plus interest will commence. The loan is secured by a first priority pledge of 100% of the issued and outstanding stock of the Bank. The Company may prepay any amount due under the promissory note at any time without premium or penalty.

 

The loan agreement contains customary representations, warranties, covenants and events of default, including the following financial covenants: (i) the Company must maintain minimum cash on hand of not less than $2,500,000, (ii) the Company must maintain a total risk based capital ratio at least equal to 10% of risk-weighted assets, (iii) the Bank must maintain a total risk based capital ratio at least equal to 11% of risk-weighted assets, and (iv) non-performing assets of the Bank may not exceed 2.5% of the Bank’s total assets. Both the Company and Bank were in compliance with the covenants as of September 30, 2019.

 

 

Note 8 – Fair Values Measurement

 

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Various valuation techniques are used to determine fair value, including market, income and cost approaches. There are three levels of inputs that may be used to measure fair values:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that an entity has the ability to access as of the measurement date, or observable inputs.

 

 

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, the fair value hierarchy is classified on the lowest level of input that is significant to the fair value measurement. The following methods and significant assumptions are used to estimate fair value.

 

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. This valuation method is classified as Level 3 in the fair value hierarchy. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

 

Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

 

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

 

Management routinely applies internal discounts to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined to have a thin trading market or to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

 

Management also applies discounts to the expected fair value of collateral for impaired loans where the likely resolution involves litigation or foreclosure. Resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment. Discounts ranging from 10% to 33% have been utilized in our impairment evaluations when applicable.

 

Impaired loans are evaluated quarterly for additional impairment. Management obtains updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and the assessment of deterioration of real estate values in the market in which the property is located.

 

Other Real Estate Owned (OREO): OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal evaluation less estimated cost to sell. Quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, management consults with staff from the Bank’s special assets group as well as external realtors and appraisers. Based on these consultations, management determines asking prices for OREO properties being marketed for sale. If the internally evaluated fair value or asking price is below the recorded investment in the property, appropriate write-downs are taken.

 

For larger dollar commercial real estate properties, management obtains a new appraisal of the subject property or has staff in the special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Management generally obtains updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. When an asking price is lowered below the most recent appraised value, appropriate write-downs are taken.

 

 

Financial assets measured at fair value on a recurring basis at September 30, 2019 and December 31, 2018 are summarized below:

 

           

Fair Value Measurements at September 30, 2019 Using

 
           

(in thousands)

 
           

Quoted Prices In

           

Significant

 
           

Active Markets for

   

Significant Other

   

Unobservable

 
   

Carrying

   

Identical Assets

   

Observable Inputs

   

Inputs

 

Description

 

Value

   

(Level 1)

   

(Level 2)

   

(Level 3)

 

Available for sale securities

                               

U.S. Government and federal agency

  $ 22,935     $     $ 22,935     $  

Agency mortgage-backed: residential

    90,102             90,102        

Collateralized loan obligations

    49,596             49,596        

State and municipal

    29,633             29,633        

Corporate bonds

    11,115             11,115        

Total

  $ 203,381     $     $ 203,381     $  

 

           

Fair Value Measurements at December 31, 2018 Using

 
           

(in thousands)

 

Description

 

Carrying

Value

   

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

   

Significant Other

Observable Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

Available for sale securities

                               

U.S. Government and federal agency

  $ 22,560     $     $ 22,560     $  

Agency mortgage-backed: residential

    85,990             85,990        

Collateralized loan obligations

    49,839             49,839        

State and municipal

    32,812             32,812        

Corporate bonds

    9,991             9,991        

Total

  $ 201,192     $     $ 201,192     $  

 

 

There were no transfers between Level 1 and Level 2 during 2019 or 2018.

 

 

Financial assets measured at fair value on a non-recurring basis are summarized below: 

 

           

Fair Value Measurements at September 30, 2019 Using

 
           

(in thousands)

 
Description   

Carrying

Value

   

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

   

 

Significant Other

Observable Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

Impaired loans:

                               

Commercial

  $ 24     $     $     $ 24  

Commercial real estate:

                               

Construction

                       

Farmland

    259                   259  

Nonfarm nonresidential

                       

Residential real estate:

                               

Multi-family

                       

1-4 Family

                       

Consumer

                       

Agriculture

                       

Other

                       

Other real estate owned:

                               

Commercial real estate:

                               

Construction, land development, and other land

    3,225                   3,225  

Farmland

                       

Nonfarm nonresidential

                       

Residential real estate:

                               

Multi-family

                       

1-4 Family

                       

 

 

           

Fair Value Measurements at December 31, 2018 Using

 
           

(in thousands)

 

Description

 

Carrying

Value

   

Quoted Prices In

Active Markets for

Identical Assets

(Level 1)

   

 

Significant Other

Observable Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

Impaired loans:

                               

Commercial

  $     $     $     $  

Commercial real estate:

                               

Construction

                       

Farmland

                       

Nonfarm nonresidential

    124                   124  

Residential real estate:

                               

Multi-family

                       

1-4 Family

    552                   552  

Consumer

                       

Agriculture

                       

Other

                       

Other real estate owned, net:

                               

Commercial real estate:

                               

Construction

    3,485                   3,485  

Farmland

                       

Nonfarm nonresidential

                       

Residential real estate:

                               

Multi-family

                       

1-4 Family

                       

 

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $316,000 at September 30, 2019 with a valuation allowance of $33,000, resulting in no additional provision for loan losses for the three and nine months ended September 30, 2019, respectively. Impaired loans had a carrying amount of $922,000 with a valuation allowance of $236,000, resulting in no additional provision for loan losses and an additional provision for loan losses of $18,000, respectively, for the three and nine months ended September 30, 2018. At December 31, 2018, impaired loans had a carrying amount of $879,000, with a valuation allowance of $203,000.

 

 

OREO, which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $3.2 million as of September 30, 2019, compared with $3.8 million at September 30, 2018 and $3.5 million at December 31, 2018. There were no fair value write-downs and $260,000 for the three and nine months ended September 30, 2019, respectively, compared to write-downs of $260,000 and $585,000 for the three and nine months ended September 30, 2018, respectively.

 

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2019:

 

   

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted

Average)

 
   

(in thousands)

                   
                           
                           

Other real estate owned – Commercial real estate

  $ 3,225  

Sales comparison approach

 

Adjustment for differences between the comparable sales

  0% - 35% (18%)  
                           
          Income approach   Discount or capitalization rate     25%   (25%)  

 

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2018:

 

   

Fair Value

 

Valuation

Technique(s)

 

Unobservable Input(s)

 

Range (Weighted

Average)

 
   

(in thousands)

                   
                           

Impaired loans – Residential real estate

  $ 552  

Sales comparison approach

 

Adjustment for differences between the comparable sales

  0% - 26% (11%)  
                           

Other real estate owned – Commercial real estate

  $ 3,485  

Sales comparison approach

 

Adjustment for differences between the comparable sales

  0% - 35% (18%)  
                           
         

Income approach

 

Discount or capitalization rate

    25%   (25%)  

 

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:

 

           

Fair Value Measurements at September 30, 2019 Using

 
   

Carrying

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 
   

(in thousands)

 

Financial assets

                                       

Cash and cash equivalents

  $ 58,007     $ 58,007     $     $     $ 58,007  

Securities available for sale

    203,381             203,381             203,381  

Federal Home Loan Bank stock

    6,467       N/A       N/A       N/A       N/A  

Loans, net

    794,665                   800,007       800,007  

Accrued interest receivable

    4,005             1,140       2,865       4,005  

Financial liabilities

                                       

Deposits

  $ 923,434     $ 151,524     $ 772,114     $     $ 923,638  

Federal Home Loan Bank advances

    56,430             56,432             56,432  

Junior subordinated debentures

    21,000                   16,975       16,975  

Subordinated capital note

    17,000                

17,222

   

17,222

 

Senior Debt

    5,000                   4,951       4,951  

Accrued interest payable

    852             612       240       852  

 

 

           

Fair Value Measurements at December 31, 2018 Using

 
   

Carrying

Amount

   

Level 1

   

Level 2

   

Level 3

   

Total

 
   

(in thousands)

 

Financial assets

                                       

Cash and cash equivalents

  $ 35,361     $ 35,361     $     $     $ 35,361  

Securities available for sale

    201,192             201,192             201,192  

Federal Home Loan Bank stock

    7,233       N/A       N/A       N/A       N/A  

Loans, net

    756,364                   744,076       744,076  

Accrued interest receivable

    3,665             1,222       2,443       3,665  

Financial liabilities

                                       

Deposits

  $ 894,231     $ 142,618     $ 750,015     $     $ 892,633  

Federal Home Loan Bank advances

    46,549             46,519             46,519  

Junior subordinated debentures

    21,000                   16,226       16,226  

Senior Debt

    10,000                   9,585       9,585  

Accrued interest payable

    658             598       60       658  

 

In accordance with the Company’s adoption of ASU 2016-01 as of January 1, 2018, the methods utilized to measure the fair value of financial instruments at September 30, 2019 and December 31, 2018 represent an approximation of exit price; however, an actual exit price may differ.

 

 

Note 9 – Income Taxes

 

Deferred tax assets and liabilities were due to the following as of:

 

   

September

30,

   

December

31,

 
   

2019

   

2018

 
   

(in thousands)

 

Deferred tax assets:

               

Net operating loss carry-forward

  $ 23,165     $ 23,390  

Allowance for loan losses

    2,222       1,865  

OREO write-down

    2,665       2,611  

Alternative minimum tax credit carry-forward

    173       346  

Net assets from acquisitions

    268       290  

Net unrealized loss on securities

          515  

New market tax credit carry-forward

    208       208  

Nonaccrual loan interest

    295       235  

Accrued expenses

    112       239  

Deferred compensation

          267  

Other

    403       241  
      29,511       30,207  
                 

Deferred tax liabilities:

               

FHLB stock dividends

    584       557  

Fixed assets

    43       94  

Deferred loan costs

    154       136  

Net unrealized gain on securities

    505        

Other

    196       138  
      1,482       925  

Net deferred tax asset

  $ 28,029     $ 29,282  

 

During the first quarter of 2019, the Company benefited $341,000, or approximately $0.05 per basic and diluted share, from the establishment of a net deferred tax asset related to a change in Kentucky tax law enacted during the first quarter. The new law eliminates the Kentucky bank franchise tax, which is assessed at a rate of 1.1% of average capital, and implements a state income tax for the Bank at a statutory rate of 5%. The new Kentucky income tax will go into effect on January 1, 2021.

 

In addition, the Company has state net operating loss carryforwards (“NOLs”) of $30.9 million, which were previously subject to a full valuation allowance and will begin to expire in 2025. In April 2019, tax legislation was enacted which allowed for certain Kentucky NOLs to be utilized in a combined filing return. Therefore, the Company will begin filing a Kentucky combined filing in 2021 and, as a result, a state NOL tax benefit, net of federal impact, of $1.2 million, or approximately $0.16 per basic and diluted share, was recognized in the second quarter of 2019.

 

 

At September 30, 2019, the Company had net federal operating loss carryforwards of $104.5 million, which will begin to expire in 2032. As of September 30, 2019, a total of $173,000 in alternative minimum tax credit carryforward was reclassified to other assets as it is currently refundable for the 2019 tax year.

 

The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the income statement or accrued for the three or nine months ended September 30, 2019 or September 30, 2018 related to unrecognized tax benefits.

 

Under Section 382 of the Internal Revenue Code, as amended (“Section 382”), the Company’s net operating loss carryforwards and other deferred tax assets can generally be used to offset future taxable income and therefore reduce federal income tax obligations. However, the Company's ability to use its NOLs would be limited if there was an “ownership change” as defined by Section 382. This would occur if shareholders owning (or deemed to own under the tax rules) 5% or more of the Company's voting and non-voting common shares increase their aggregate ownership of the Company by more than 50 percentage points over a defined period of time.

 

In 2015, the Company took two measures to preserve the value of its NOLs. First, the Company adopted a tax benefits preservation plan designed to reduce the likelihood of an “ownership change” occurring as a result of purchases and sales of the Company's common shares. Upon adoption of this plan, the Company declared a dividend of one preferred stock purchase right for each common share outstanding as of the close of business on July 10, 2015. Any shareholder or group that acquires beneficial ownership of 5% or more of the Company (an “acquiring person”) could be subject to significant dilution in its holdings if the Company's Board of Directors does not approve such acquisition. Existing shareholders holding 5% or more of the Company will not be considered acquiring persons unless they acquire additional shares, subject to certain exceptions described in the plan. In addition, the Board of Directors has the discretion to exempt certain transactions and certain persons whose acquisition of securities is determined by the Board not to jeopardize the Company's deferred tax assets. The rights plan was extended in May 2018 to expire upon the earlier of (i) June 30, 2021, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefits may be carried forward, (iii) the repeal or amendment of Section 382 or any successor statute, if the Board of Directors determines that the plan is no longer needed to preserve the tax benefits, and (iv) certain other events as described in the plan.

 

On September 23, 2015, the Company’s shareholders approved an amendment to its articles of incorporation to further help protect the long-term value of the Company’s NOLs. The amendment provides a means to block transfers of our common shares that could result in an ownership change under Section 382. The transfer restrictions were extended in May 2018 by shareholder vote and will expire on the earlier of (i) May 23, 2021, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefit may be carried forward, (iii) the repeal of Section 382 or any successor statute if our Board determines that the transfer restrictions are no longer needed to preserve the tax benefits of our NOLs, or (iv) such date as the Board otherwise determines that the transfer restrictions are no longer necessary.

 

The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to income tax in the Commonwealth of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2016.

 

 

Note 10 – Stock Plans and Stock Based Compensation

 

Shares available for issuance under the 2018 Omnibus Equity Compensation Plan (“2018 Plan”) total 292,890. Shares issued to employees under the plan vest annually on the anniversary date of the grant over three years. Shares issued annually to non-employee directors have a fair market value of $25,000 and vest on December 31 in the year of grant.

 

The fair value of the 2019 unvested shares issued was $501,000, or $14.80 per weighted-average share. The Company recorded $181,000 and $356,000 of stock-based compensation to salaries for the three and nine months ended September 30, 2019, respectively, and $171,000 and $334,000 for the three and nine months ended September 30, 2018, respectively. Management expects substantially all of the unvested shares outstanding at the end of the period to vest according to the vesting schedule. A deferred tax benefit of $38,000 and $75,000 was recognized related to this expense during the three and nine months ended September 30, 2019, respectively, and $36,000 and $70,000 for the three and nine months ended September 30, 2018.

 

 

The following table summarizes unvested share activity as of and for the periods indicated for the Stock Compensation Plan:

 

   

Nine Months Ended

   

Twelve Months Ended

 
   

September 30, 2019

   

December 31, 2018

 
           

Weighted

           

Weighted

 
           

Average

           

Average

 
           

Grant

           

Grant

 
   

Shares

   

Price

   

Shares

   

Price

 

Outstanding, beginning

    116,909     $ 8.69       142,334     $ 5.67  

Granted

    33,858       14.80       52,856       13.94  

Vested

    (75,981

)

    6.57       (78,281

)

    6.75  

Forfeited

    (3,998

)

    13.04              

Outstanding, ending

    70,788     $ 13.64       116,909     $ 8.69  

 

 

Unrecognized stock based compensation expense related to unvested shares for the remainder of 2019 and beyond is estimated as follows (in thousands):

 

October 2019 – December 2019

  $ 180  

2020

    306  

2021

    192  

2022

    17  

 

 

Note 11 – Earnings per Share

 

The factors used in the basic and diluted earnings per share computations follow:

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30,

   

September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

(in thousands, except share and per share data)

 
                                 

Net income

  $ 2,282     $ 2,437     $ 8,754     $ 6,354  

Less:

                               

Earnings allocated to unvested shares

    20       40       93       105  

Net income available to common shareholders, basic and diluted

  $ 2,262     $ 2,397     $ 8,661     $ 6,249  
                                 

Basic

                               

Weighted average common shares including unvested common shares outstanding

    7,471,582       7,455,316       7,467,048       7,059,472  

Less:

                               

Weighted average unvested common shares

    63,913       122,097       79,411       117,060  

Weighted average common shares outstanding

    7,407,669       7,333,219       7,387,637       6,942,412  

Basic income per common share

  $ 0.31     $ 0.33     $ 1.17     $ 0.90  
                                 

Diluted

                               

Add: Dilutive effects of assumed exercises of common stock warrants

                       

Weighted average common shares and potential common shares

    7,407,669       7,333,219       7,387,637       6,942,412  

Diluted income per common share

  $ 0.31     $ 0.33     $ 1.17     $ 0.90  

 

The Company had no outstanding stock options at September 30, 2019 or 2018. A warrant for the purchase of 66,113 shares of the Company’s common stock at an exercise price of $79.41 was outstanding at September 30, 2018, but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. The warrant expired on November 21, 2018.

 

 

Note 12Regulatory Capital Matters

 

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can result in regulatory action.

 

 

The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. Banks (Basel III rules) became effective for the Company and Bank on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule through January 1, 2019. The final rules allowed banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5% above the regulatory minimum risk-based capital ratios. With the capital conservation buffer fully phased in as of January 1, 2019, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%. The capital conservation buffer for 2019 is 2.5% and was 1.875% for 2018. An institution is subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions without prior regulatory approval.

 

The Company’s capital ratios were positively impacted by the $17.0 million of subordinated notes issued during the third quarter, as the subordinated notes meet the requirements to qualify as Tier 2 capital. The Bank’s capital ratios also benefitted as the Company contributed $10.0 million of the proceeds to the Bank as Common Equity Tier 1 Capital.

 

As of September 30, 2019, Management believes the Company and Bank met all capital adequacy requirements to which they are subject. As of September 30, 2019, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since the notification that management believes have changed the institution’s category.

 

The following tables show the ratios (excluding capital conservation buffer) and amounts of common equity Tier 1, Tier 1 capital, and total capital to risk-adjusted assets and the leverage ratios for the Bank at the dates indicated (dollars in thousands):

 

   

Actual

   

Minimum Requirement

for Capital Adequacy

Purposes

   

Minimum Requirement

to be Well Capitalized

Under Prompt Corrective

Action Provisions

 
   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 

As of September 30, 2019:

                                               

Total risk-based capital (to risk- weighted assets)

  $ 130,363       14.89     $ 70,061       8.00     $ 87,576       10.00

%

Total common equity Tier 1 risk- based capital (to risk-weighted assets)

    121,459       13.87       39,409       4.50       56,924       6.50  

Tier 1 capital (to risk-weighted assets)

    121,459       13.87       52,545       6.00       70,061       8.00  

Tier 1 capital (to average assets)

    121,459       11.25       43,185       4.00       53,981       5.00  

 

 

   

Actual

   

Minimum Requirement

for Capital Adequacy

Purposes

   

Minimum Requirement

to be Well Capitalized

Under Prompt Corrective

Action Provisions

 
   

Amount

   

Ratio

   

Amount

   

Ratio

   

Amount

   

Ratio

 

As of December 31, 2018:

                                               

Total risk-based capital (to risk- weighted assets)

  $ 109,309       12.88

%

  $ 67,920       8.00

%

  $ 84,900       10.00

%

Total common equity Tier 1 risk- based capital (to risk-weighted assets)

    100,429       11.83       38,205       4.50       55,185       6.50  

Tier 1 capital (to risk-weighted assets)

    100,429       11.83       50,940       6.00       67,920       8.00  

Tier 1 capital (to average assets)

    100,429       9.60       41,837       4.00       52,297       5.00  

 

 

Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval. These laws limit the amount of dividends that may be paid in any calendar year to current year’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. In addition, a bank must have positive retained earnings.

 

 

 

Note 13Off Balance Sheet Risks, Commitments, and Contingent Liabilities

 

The Company, in the normal course of business, is party to financial instruments with off balance sheet risk. The financial instruments include commitments to extend credit and standby letters of credit. The contract or notional amounts of these instruments reflect the potential future obligations of the Company pursuant to those financial instruments. Creditworthiness for all instruments is evaluated on a case-by-case basis in accordance with the Company’s credit policies. Collateral from the client may be required based on the Company’s credit evaluation of the client and may include business assets of commercial clients, as well as personal property and real estate of individual clients or guarantors.

 

An approved but unfunded loan commitment represents a potential credit risk and a liquidity risk, since the Company’s client(s) may demand immediate cash that would require funding. In addition, unfunded loan commitments represent interest rate risk as market interest rates may rise above the rate committed to the Company’s client. Since a portion of these loan commitments normally expire unused, the total amount of outstanding commitments at any point in time may not require future funding. Commitments to make loans are generally made for periods of one year or less.

 

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a client to a third party. The terms and risk of loss involved in issuing standby letters of credit are similar to those involved in issuing loan commitments and extending credit. In addition to credit risk, the Company also has liquidity risk associated with standby letters of credit because funding for these obligations could be required immediately. The Company does not deem this risk to be material. No liability is currently established for standby letters of credit.

 

The following table presents the contractual amounts of financial instruments with off-balance sheet risk for each period ended:

 

   

September 30, 2019

   

December 31, 2018

 
   

Fixed

Rate

   

Variable

Rate

   

Fixed

Rate

   

Variable

Rate

 
   

(in thousands)

 

Commitments to make loans

  $ 7,513     $ 14,881     $ 5,317     $ 11,236  

Unused lines of credit

    8,648       71,946       7,410       73,024  

Standby letters of credit

    21       2,163       541       1,752  

 

 

 

Commitments to make loans are generally made for periods of one year or less.

 

In connection with the purchase of loan participations, the Bank entered into risk participation agreements, which had notional amounts totaling $26.6 million at September 30, 2019 and December 31, 2018. The risk participation agreements are not designated against specific assets or liabilities under ASC 815, Derivatives and Hedging, and, therefore, do not qualify for hedge accounting. The derivatives are recorded in other liabilities on the balance sheet at fair value and changes in fair value of both the borrower and the offsetting swap agreements are recorded (and essentially offset) in non-interest income.

 

In the normal course of business, the Company and its subsidiaries have been named, from time to time, as defendants in various legal actions. Certain of the actual or threatened legal actions may include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages.

 

The Company contests liability and/or the amount of damages as appropriate in each pending matter. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in the early stages, the Company cannot predict with certainty the loss or range of loss, if any, related to such matters, how or if such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, or other relief, if any, might be. Subject to the foregoing, the Company believes, based on current knowledge and after consultation with counsel, that the outcome of such pending matters will not have a material adverse effect on the consolidated financial condition of the Company, although the outcome of such matters could be material to the Company’s operating results and cash flows for a particular future period, depending on, among other things, the level of the Company’s revenues or income for such period. The Company will accrue for a loss contingency if (1) it is probable that a future event will occur and confirm the loss and (2) the amount of the loss can be reasonably estimated. The Company is not currently involved in any material litigation.

 

 

Note 14 – Revenue from Contracts with Customers

 

All of the Company’s revenue from customers within the scope of ASC 606 is recognized as non-interest income. A description of the Company’s revenue streams accounted for under ASC 606 follows:

 

Service Charges on Deposit Accounts: The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges are withdrawn from the customer’s account balance.

 

 

Bank Card Interchange Income: The Company earns interchange fees from bank cardholder transactions conducted through a third party payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. Prior to adopting ASC 606, the Company reported bank card interchange fees net of expenses. Under ASC 606, bank card interchange fees are reported gross.

 

Gains/Losses on Sales of OREO: The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. Gains and losses on sales of OREO are netted with OREO expense and reported in non-interest expense.

 

Other Non-interest Income: Other non-interest income includes revenue from several sources that are within the scope of ASC 606, including title insurance commissions, income from secondary market loan sales, and other transaction-based revenue that is individually immaterial. Other non-interest income included approximately $133,000 and $388,000 of revenue for the three and nine months ended September 30, 2019, respectively, within the scope of ASC 606. Other non-interest income included approximately $301,000 and $546,000 of revenue for the three and nine months ended September 30, 2018, respectively, within the scope of ASC 606. The remaining other non-interest income for the three and nine months is excluded from the scope of ASC 606.

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This item analyzes the Company’s financial condition, change in financial condition and results of operations. It should be read in conjunction with the unaudited consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

 

Preliminary Note Concerning Forward-Looking Statements

 

This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

 

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include the assumptions or bases underlying the forward-looking statement. Management has made assumptions and bases in good faith and believe they are reasonable. However, that estimates based on such assumptions or bases frequently differ from actual results, and the differences can be material. The forward-looking statements included in this report speak only as of the date of the report. Management does not intend to update these statements unless required by applicable laws.

 

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of management’s control. Factors that could contribute to differences in results include, but are not limited to the following:

 

 

Changes in fiscal, monetary, regulatory and tax policies;

 

Changes in political and economic conditions;

 

The magnitude and frequency of changes to the Federal Funds Target Rate implemented by the Federal Open Market Committee of the Federal Reserve Bank;

 

Long-term and short-term interest rate fluctuations as well as the overall steepness of the yield curve;

 

Competitive product and pricing pressures;

 

Equity and fixed income market fluctuations;

 

Client bankruptcies and loan defaults;

 

Inflation;

 

Recession;

 

Natural disasters impacting Company operations;

 

Future acquisitions;

 

Integrations and performance of acquired businesses;

 

Changes in technology and regulations or the interpretation and enforcement thereof;

 

Changes in accounting standards;

 

Changes to the Company’s overall internal control environment;

 

Success in gaining regulatory approvals when required;

 

 

 

Information security breaches or cyber security attacks involving either the Company or one of the Company’s third-party service providers; and

 

Other risks and uncertainties reported from time to time in the Company’s filings with the Securities and Exchange Commission (“SEC”), including Part 1 Item 1A “Risk Factors” of the Company’s December 31, 2018 Annual Report on Form 10-K for the year ended December 31, 2018.

 

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include the assumptions or bases underlying the forward-looking statement. Management has made assumptions and bases in good faith and believe they are reasonable. However, that estimates based on such assumptions or bases frequently differ from actual results, and the differences can be material. The forward-looking statements included in this report speak only as of the date of the report. Management does not intend to update these statements unless required by applicable laws.

 

Overview

 

The Company is a bank holding company headquartered in Louisville, Kentucky. The Company’s common stock is traded on Nasdaq’s Capital Market under the symbol LMST. The Company operates Limestone Bank (the Bank), our wholly owned subsidiary and the eleventh largest bank domiciled in the Commonwealth of Kentucky based on total assets. The Bank operates banking offices in twelve counties in Kentucky. The Bank’s markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt. The Bank serves south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio, and Daviess Counties. The Bank also has an office in Lexington, the second largest city in Kentucky. The Bank is a community bank with a wide range of commercial and personal banking products. As of September 30, 2019, the Company had total assets of $1.1 billion, total loans of $803.6 million, total deposits of $923.4 million and stockholders’ equity of $104.3 million.

 

The Company reported net income of $2.3 million and $8.8 million for the three and nine months ended September 30, 2019, compared with net income of $2.4 million and $6.4 million for the same periods of 2018. Income tax expense was $531,000 and $43,000 for the third quarter of 2019 and for the first nine months of 2019, respectively, compared to income tax expense of $604,000 and $1.4 million for the third quarter of 2018 and for the first nine months of 2018, respectively.

 

Highlights for the nine months ended September 30, 2019 are as follows:

 

 

Loan growth outpaced paydowns during the period. Average loans receivable increased approximately $50.9 million or 6.9% to $786.8 million for the nine months ended September 30, 2019, compared with $735.9 million for the first nine months of 2018. This resulted in an increase in interest revenue volume of approximately $2.0 million for the nine months September 30, 2019 compared with the nine months of 2018.

 

 

Net interest margin decreased nine basis points to 3.46% in the first nine months of 2019 compared with 3.55% in the first nine months of 2018. The yield on earning assets increased to 4.83% for the first nine months of 2019, compared to 4.51% for the first nine months of 2018. The cost of interest-bearing liabilities increased from 1.14% in the first nine months of 2018 to 1.67% in the first nine months of 2019 as a result of increases in short-term interest rates during 2018.

 

 

The Company recorded no provision for loan losses expense during the first nine months of 2019, compared to a negative provision for loan losses of $500,000 during the first nine months of 2018. Historical loss experience, risk grade classification metrics, charge-off levels, and past due trends remain at historically strong levels and were generally stable between periods. Net loan recoveries were $24,000 for the first nine months of 2019, compared to net recoveries of $932,000 for the first nine months of 2018.

 

 

Loans past due 30-59 days decreased from $1.6 million at December 31, 2018 to $979,000 at September 30, 2019, and loans past due 60-89 days increased from $331,000 at December 31, 2018 to $557,000 at September 30, 2019. Total loans past due and nonaccrual loans remained unchanged at $3.9 million from December 31, 2018 to September 30, 2019.

 

 

Loans graded pass increased $8.4 million, loans graded watch increased $24.4 million, loans graded special mention were flat, and loans graded substandard increased $5.6 million as compared to December 31, 2018.

 

 

Foreclosed properties were $3.2 million at September 30, 2019, compared with $3.5 million at December 31, 2018, and $3.8 million at September 30, 2018. Operating expenses and fair value write downs totaled $333,000 for the first nine months of 2019 compared to operating expenses, fair value write downs, and net gain on sales of $590,000 for the first nine months of 2018.

 

 

The ratio of non-performing assets to total assets decreased to 0.51% at September 30, 2019, compared with 0.60% at December 31, 2018, and 0.70% at September 30, 2018.

 

 

 

Deposits were $923.4 million at September 30, 2019, compared with $894.2 million at December 31, 2018. Certificate of deposit balances increased $37.2 million during the first nine months of 2019 to $488.1 million at September 30, 2019, from $450.9 million at December 31, 2018. Interest checking accounts increased $1.2 million, non-interest bearing accounts increased $8.9 million, and money market declined $18.3 million during the first nine months of 2019 compared with December 31, 2018.

 

 

On July 23, 2019, the Company completed the issuance of a $17.0 million 10-year subordinated note. The note carries interest at a fixed rate of 5.75% for the first five years and qualifies as Tier 2 regulatory capital. The Company contributed $10.0 million of the proceeds to the Bank as Tier 1 capital, used $5.0 million to reduce senior debt, and retained the remaining proceeds for general corporate purposes.

 

 

In July 2019, the Bank entered into a Branch Purchase and Assumption Agreement to acquire four branch banking centers located in the Kentucky cities of Elizabethtown, Frankfort, and Owensboro from Louisville, Kentucky based Republic Bank and Trust Company ("Republic"). Under the terms of the agreement, the Bank will acquire the four branch offices, which includes $142 million in deposits and $131 million in loans. The $131 million of loan balances to be purchased include approximately $20 million of additional loans, primarily mortgage-related, that Republic and the Bank have further agreed to include in the transaction since the date of the original announcement and have been reduced by approximately $965,000 of credit card balances that Republic and the Bank have agreed to remove from the transaction. In addition, the Bank will acquire substantially all the fixed assets of these locations. The transaction has received regulatory approval. The transaction includes an all-in blended deposit premium of approximately 6%. Estimated tangible book value dilution is approximately 9%. The tangible book value earn back period based upon preliminary earnings estimates for the acquired branches is expected to be less than three years. The final calculated premium will be primarily based on the trailing 10-day average amount of the deposits as of the closing date, as well as the branch location for the deposits. The transaction is expected to close on or about November 15, 2019.

 

 

During the first quarter of 2019, the Company benefited $341,000, or approximately $0.05 per basic and diluted share, from the establishment of a net deferred tax asset related to a change in Kentucky tax law enacted during the first quarter. The new law eliminates the Kentucky bank franchise tax, which is assessed at a rate of 1.1% of average capital, and implements a state income tax for the Bank at a statutory rate of 5%. The new Kentucky income tax will go into effect on January 1, 2021. In addition, the Company has state net operating loss carryforwards (“NOLs”) of $30.9 million, which were previously subject to a full valuation allowance and will begin to expire in 2025. In April 2019, tax legislation was enacted which allowed for certain Kentucky NOLs to be utilized in a combined filing return. Therefore, the Company will begin filing a Kentucky combined filing in 2021 and, as a result, a state NOL tax benefit, net of federal impact, of $1.2 million, or approximately $0.16 per basic and diluted share, was recognized in the second quarter of 2019.

 

Application of Critical Accounting Policies

 

Management continually reviews accounting policies and financial information disclosures. The Company’s more significant accounting policies that require the use of estimates and judgments in preparing the financial statements are summarized in “Application of Critical Accounting Policies” in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation of our Annual Report on Form 10-K for the calendar year ended December 31, 2018. Management has discussed the development, selection, and application of our critical accounting policies with our Audit Committee. During the first nine months of 2019, there were no material changes in the critical accounting policies and assumptions.

 

Results of Operations

 

The following table summarizes components of income and expense and the change in those components for the three months ended September 30, 2019, compared with the same period of 2018:

 

   

For the Three Months

   

Change from

 
   

Ended September 30,

   

Prior Period

 
   

2019

   

2018

   

Amount

   

Percent

 
   

(dollars in thousands)

 
                                 

Gross interest income

  $ 12,485     $ 11,120     $ 1,365       12.3

%

Gross interest expense

    3,755       2,708       1,047       38.7  

Net interest income

    8,730       8,412       318       3.8  

Provision (negative provision) for loan losses

          (350

)

    350       (100.0

)

Non-interest income

    1,534       1,509       25       1.7  

Non-interest expense

    7,451       7,230       221       3.1  

Net income before taxes

    2,813       3,041       (228

)

    (7.5

)

Income tax expense

    531       604       (73

)

    (12.1

)

Net income

    2,282       2,437       (155

)

    (6.4

)

 

Net income for the three months ended September 30, 2019 totaled $2.3 million, compared with $2.4 million for the comparable period of 2018. Net income before taxes and income tax expense was $2.8 million and $531,000, respectively, for the third quarter of 2019, compared with $3.0 million and income tax expense of $604,000, respectively for the third quarter of 2018.

 

 

Net interest income increased $318,000 from the 2018 third quarter as a result of an increase in earning assets. Net interest margin decreased 10 basis points to 3.35% in the third quarter of 2019 compared with 3.45% in the third quarter of 2018. The cost of interest-bearing liabilities increased from 1.32% for the third quarter of 2018 to 1.75% for the third quarter of 2019, while the yield on interest earning assets increased from 4.56% to 4.79% for the same period. Average earning assets increased from $968.9 million for the third quarter of 2018 to $1.0 billion for the third quarter of 2019. Non-interest income increased by $25,000 to $1.5 million from $1.5 million in the third quarter of 2018 primarily due to an increase in bankcard interchange fees of $212,000 partially offset by a decrease in other non-interest income primarily related to a $150,000 one-time gain on the sale of the Bank’s secondary market residential mortgage servicing rights portfolio during the third quarter of 2018. Non-interest expense increased from $7.2 million in the third quarter of 2018 to $7.5 million in the third quarter of 2019 primarily due to an increase of $309,000 in salaries and employee benefits.

 

The following table summarizes components of income and expense and the change in those components for the nine months ended September 30, 2019, compared with the same period of 2018:

 

   

For the Nine Months

   

Change from

 
   

Ended September 30,

   

Prior Period

 
   

2019

   

2018

   

Amount

   

Percent

 
   

(dollars in thousands)

 
                                 

Gross interest income

  $ 37,047     $ 31,720     $ 5,327       16.8

%

Gross interest expense

    10,558       6,753       3,805       56.3  

Net interest income

    26,489       24,967       1,522       6.1  

Provision (negative provision) for loan losses

          (500

)

    500       (100.0

)

Non-interest income

    4,264       4,107       157       3.8  

Non-interest expense

    21,956       21,804       152       0.7  

Net income before taxes

    8,797       7,770       1,027       13.2  

Income tax expense

    43       1,416       (1,373

)

    (97.0

)

Net income

    8,754       6,354       2,400       37.8  

 

Net income for the nine months ended September 30, 2019 totaled $8.8 million, compared with net income of $6.4 million for the comparable period of 2018. Net income before taxes and income tax expense was $8.8 million and $43,000, respectively, for the nine months ended September 30, 2019, compared with $7.8 million and income tax expense of $1.4 million, respectively, for the nine months ended September 30, 2018. Income tax expense for the first nine months of 2019 benefitted $1.6 million from the establishment of a state net deferred tax asset related to the 2019 tax law enactments discussed previously.

 

Net interest income increased $1.5 million from the first nine months of 2018 as a result of an increase in earning assets. Net interest margin decreased nine basis points to 3.46% in the first nine months of 2019 compared with 3.55% in the first nine months of 2018. The cost of interest-bearing liabilities increased from 1.14% for the first nine months of 2018 to 1.67% for the first nine months of 2019, while the yield on interest earning assets increased from 4.51% to 4.83% for the same period. Average earning assets increased from $942.7 million for the first nine months of 2018 to $1.0 billion for the first nine months of 2019. Non-interest income increased by $157,000 to $4.3 million from $4.1 million in the first nine months of 2018 primarily due to an increase in bankcard interchange fees of $469,000 partially offset by a decrease in other non-interest income primarily related to a $150,000 one-time gain on the sale of the secondary market residential servicing rights portfolio. Non-interest expense increased from $21.8 million in the first nine months of 2018 to $22.0 million in the first nine months of 2019 primarily due to an increase of $466,000 in salary and employee benefits, as the Bank added sales talent and customer facing associates during the second and third quarters of 2019, and $238,000 in deposit account related expense partially offset by decreases in OREO expenses of $257,000, and FDIC insurance expense of $228,000.

 

Net Interest Income – Net interest income was $8.7 million for the three months ended September 30, 2019, an increase of $318,000, or 3.8%, compared with $8.4 million for the same period in 2018. Net interest spread and margin were 3.04% and 3.35%, respectively, for the third quarter of 2019, compared with 3.24% and 3.45%, respectively, for the third quarter of 2018. Net average non-accrual loans were $2.4 million and $3.0 million for the third quarters of 2019 and 2018, respectively.

 

Average loans receivable increased approximately $51.8 million for the third quarter of 2019 compared with the third quarter of 2018. This resulted in an increase in interest revenue of approximately $678,000 attributable to volume and an increase of $454,000 attributable to increasing interest rates for the quarter ended September 30, 2019, compared with the third quarter of 2018. Interest foregone on non-accrual loans totaled $74,000 for the third quarter of 2019, compared with $59,000 for the third quarter of 2018.

 

Net interest margin decreased 10 basis points from 3.45% in the prior year third quarter to 3.35% for the third quarter of 2019. The yield on earning assets increased 23 basis points and rates paid on interest-bearing liabilities increased 43 basis points from the third quarter of 2018. Both the yield on earning assets and cost of interest-bearing liabilities were impacted by increases in short-term interest rates during 2018, as well as the two 25 basis point cuts by the Federal Reserve in its fed funds target rate on July 31, 2019 and September 18, 2019.

 

 

Net interest income was $26.5 million for the nine months ended September 30, 2019, an increase of $1.5 million, or 6.1%, compared with $25.0 million for the same period in 2018. Net interest spread and margin were 3.16% and 3.46%, respectively, for the first nine months of 2019, compared with 3.37% and 3.55%, respectively, for the first nine months of 2018. Net average non-accrual loans were $2.3 million and $4.0 million for the first nine months of 2019 and 2018, respectively.

 

Average loans receivable increased approximately $51.0 million for the nine months ended September 30, 2019 compared with the first nine months of 2018. This resulted in an increase in interest revenue of approximately $2.0 million attributable to volume and an increase of $2.0 million attributable to increasing in interest rates for the nine months ended September 30, 2019 compared with the prior year period. Interest foregone on non-accrual loans totaled $238,000 for the nine months ended September 30, 2019, compared with $220,000 for the nine months ended September 30, 2018.

 

Net interest margin decreased nine basis points to 3.46% for the first nine months of 2019 from 3.55% in the first nine months of 2018. The yield on earning assets increased 32 basis points for the first nine months of 2019 from the first nine months of 2018, compared with an increase in rates paid on interest-bearing liabilities of 53 basis points between the two periods. Both the yield on earning assets and cost of interest-bearing liabilities were impacted by increases in short-term interest rates during 2018, as well as the two 25 basis point rate cuts in July and September 2019.

 

 

Average Balance Sheets

 

The following table presents the average balance sheets for the three-month periods ended September 30, 2019 and 2018, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

   

Three Months Ended September 30,

 
   

2019

   

2018

 
   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

 
   

(dollars in thousands)

 

ASSETS

                                               

Interest-earning assets:

                                               

Loan receivables (1)(2)

  $ 800,194     $ 10,671       5.29

%

  $ 748,444     $ 9,539       5.06

%

Securities

                                               

Taxable

    193,133       1,553       3.19       167,280       1,245       2.95  

Tax-exempt (3)

    10,723       76       3.56       14,147       95       3.37  

FHLB stock

    6,593       76       4.57       7,243       110       6.03  

Federal funds sold and other

    24,879       109       1.74       31,762       131       1.64  

Total interest-earning assets

    1,035,522       12,485       4.79

%

    968,876       11,120       4.56

%

Less: Allowance for loan losses

    (8,884

)

                    (8,742

)

               

Non-interest earning assets

    78,794                       77,502                  

Total assets

  $ 1,105,432                     $ 1,037,636                  
                                                 
                                                 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

  $ 498,754     $ 2,571       2.05

%

  $ 450,125     $ 1,671       1.47

%

NOW and money market deposits

    256,373       518       0.80       251,020       445       0.70  

Savings accounts

    34,043       16       0.19       34,778       14       0.16  

FHLB advances

    23,238       132       2.25       43,995       233       2.10  

Junior subordinated debentures

    21,000       251       4.74       20,999       247       4.67  

Subordinated capital note

    12,935       190       5.83                    

Senior debt

    6,196       77       4.93       10,000       98       3.89  

Total interest-bearing liabilities

    852,539       3,755       1.75

%

    810,917       2,708       1.32

%

                                                 

Non-interest-bearing liabilities:

                                               

Non-interest-bearing deposits

    144,378                       133,784                  

Other liabilities

    4,697                       5,449                  

Total liabilities

    1,001,614                       950,150                  

Stockholders’ equity

    103,818                       87,486                  

Total liabilities and stockholders’ equity

  $ 1,105,432                     $ 1,037,636                  
                                                 

Net interest income

          $ 8,730                     $ 8,412          
                                                 

Net interest spread

                    3.04

%

                    3.24

%

                                                 

Net interest margin

                    3.35

%

                    3.45

%

 


(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans averaging $2.4 million and $3.0 million, respectively, in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a federal income tax rate of 21%.

 

 

The following table presents the average balance sheets for the nine-month periods ended September 30, 2019 and 2018, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

   

Nine Months Ended September 30,

 
   

2019

   

2018

 
   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

   

Average

Balance

   

Interest

Earned/Paid

   

Average

Yield/Cost

 
   

(dollars in thousands)

 

ASSETS

                                               

Interest-earning assets:

                                               

Loan receivables (1)(2)

  $ 786,843     $ 31,390       5.33

%

  $ 735,874     $ 27,423       4.98

%

Securities

                                               

Taxable

    193,395       4,734       3.27       157,537       3,386       2.87  

Tax-exempt (3)

    12,305       257       3.53       14,184       287       3.42  

FHLB stock

    6,811       281       5.52       7,296       320       5.86  

Federal funds sold and other

    27,090       385       1.90       27,857       304       1.46  

Total interest-earning assets

    1,026,444       37,047       4.83

%

    942,748       31,720       4.51

%

Less: Allowance for loan losses

    (8,823

)

                    (8,655

)

               

Non-interest earning assets

    76,303                       78,769                  

Total assets

  $ 1,093,924                     $ 1,012,862                  
                                                 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

  $ 482,181     $ 7,035       1.95

%

  $ 433,933     $ 4,041       1.25

%

NOW and money market deposits

    260,902       1,579       0.81       246,271       1,040       0.56  

Savings accounts

    33,829       43       0.17       35,221       42       0.16  

FHLB advances

    36,502       668       2.45       43,035       605       1.88  

Junior subordinated debentures

    21,000       772       4.92       22,057       733       4.44  

Subordinated capital note

    4,359       190       5.83                    

Senior debt

    8,718       271       4.16       10,000       292       3.90  

Total interest-bearing liabilities

    847,491       10,558       1.67

%

    790,517       6,753       1.14

%

                                                 

Non-interest-bearing liabilities:

                                               

Non-interest-bearing deposits

    143,577                       133,756                  

Other liabilities

    4,472                       5,406                  

Total liabilities

    995,540                       929,679                  

Stockholders’ equity

    98,384                       83,183                  

Total liabilities and stockholders’ equity

  $ 1,093,924                     $ 1,012,862                  
                                                 

Net interest income

          $ 26,489                     $ 24,967          
                                                 

Net interest spread

                    3.16

%

                    3.37

%

                                                 

Net interest margin

                    3.46

%

                    3.55

%

 


(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans averaging $2.3 million and $4.0 million, respectively, in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a federal income tax rate of 21%.

 

 

Rate/Volume Analysis 

 

The table below sets forth certain information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.

 

   

Three Months Ended September 30,

2019 vs. 2018

   

Nine Months Ended September 30,

2019 vs. 2018

 
   

Increase (decrease)

due to change in

   

Increase (decrease)

due to change in

 
   

Rate

   

Volume

   

Net

Change

   

Rate

   

Volume

   

Net

Change

 
   

(in thousands)

 

Interest-earning assets:

                                               

Loan receivables

  $ 454     $ 678     $ 1,132     $ 2,002     $ 1,965     $ 3,967  

Securities

    115       174       289       533       785       1,318  

FHLB stock

    (25

)

    (9

)

    (34

)

    (19

)

    (20

)

    (39

)

Federal funds sold and other

    8       (30

)

    (22

)

    89       (8

)

    81  

Total increase (decrease) in interest income

    552       813       1,365       2,605       2,722       5,327  
                                                 

Interest-bearing liabilities:

                                               

Certificates of deposit and other time deposits

    704       196       900       2,503       491       2,994  

NOW and money market accounts

    64       9       73       474       65       539  

Savings accounts

    2             2       3       (2

)

    1  

FHLB advances

    16       (117

)

    (101

)

    164       (101

)

    63  

Junior subordinated debentures

    4             4       75       (36

)

    39  

Subordinated capital note

          190       190             190       190  

Senior debt

    22       (43

)

    (21

)

    18       (39

)

    (21

)

Total increase (decrease) in interest expense

    812       235       1,047       3,237       568       3,805  

Increase (decrease) in net interest income

  $ (260

)

  $ 578     $ 318     $ (632

)

  $ 2,154     $ 1,522  

 

 

Non-Interest Income – The following table presents the major categories of non-interest income for the three and nine months ended September 30, 2019 and 2018:

 

   

For the Three Months

   

For the Nine Months

 
   

Ended September 30,

   

Ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

(dollars in thousands)

 
                                 

Service charges on deposit accounts

  $ 633     $ 608     $ 1,700     $ 1,767  

Bank card interchange fees

    623       411       1,727       1,258  

Income from bank owned life insurance

    97       100       314       337  

Net gain (loss) on sales and calls of securities

                (5

)

    (6

)

Other

    181       390       528       751  

Total non-interest income

  $ 1,534     $ 1,509     $ 4,264     $ 4,107  

 

Non-interest income for the third quarter of 2019 increased by $25,000, or 1.7%, compared with the third quarter of 2018. The increase in non-interest income for the third quarter of 2019 compared to the third quarter of 2018 was primarily driven by an increase in bank card interchange fees of $212,000 partially offset by a decrease in other non-interest income primarily related to a $150,000 one-time gain on the sale of the Bank’s secondary market residential mortgage servicing rights portfolio during the third quarter of 2018. For the nine months ended September 30, 2019, non-interest income increased by $157,000, or 3.8% to $4.3 million compared with $4.1 million for the same period of 2018. The increase in non-interest income between the nine-month comparative periods was primarily due to an increase in bank card interchange fees of $469,000 partially offset by a decrease in other non-interest income primarily related to the $150,000 one-time gain on the sale of the secondary market residential servicing rights portfolio.

 

 

Non-interest ExpenseThe following table presents the major categories of non-interest expense for the three and nine months ended September 30, 2019 and 2018:

 

   

For the Three Months

   

For the Nine Months

 
   

Ended September 30,

   

Ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

(dollars in thousands)

 
                                 

Salary and employee benefits

  $ 4,202     $ 3,893     $ 12,032     $ 11,566  

Occupancy and equipment

    880       896       2,632       2,671  

Professional fees

    254       186       598       613  

Marketing expense

    251       259       690       867  

FDIC insurance

          118       211       439  

Data processing expense

    315       281       943       912  

State franchise and deposit tax

    315       282       945       846  

Deposit account related expenses

    300       213       891       653  

Other real estate owned expense

    25       271       333       590  

Litigation and loan collection expense

    32       61       112       162  

Other

    877       770       2,569       2,485  

Total non-interest expense

  $ 7,451     $ 7,230     $ 21,956     $ 21,804  

 

Non-interest expense for the third quarter ended September 30, 2019 increased $221,000, or 3.1%, compared with the third quarter of 2018. This increase was primarily due to an increase of $309,000 in salaries and employee benefits. For the nine months ended September 30, 2019, non-interest expense increased $152,000, or 0.7% to $22.0 million compared with $21.8 million for the first nine months of 2018. The increase in non-interest expense for the nine months ended September 30, 2019 was primarily attributable to increases of $466,000 in salary and employee benefits, as the Bank added sales talent and customer facing associates during the second and third quarters of 2019, and $238,000 in deposit account related expense partially offset by decreases in OREO expenses of $257,000, and FDIC insurance expense of $228,000.

 

Income Tax Expense Effective tax rates differ from the federal statutory rate of 21% applied to income before income taxes due to the following:

 

   

For the Three Months

   

For the Nine Months

 
   

Ended September 30,

   

Ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 
   

(dollars in thousands)

 

Federal statutory rate times financial statement income

  $ 591     $ 639     $ 1,847     $ 1,632  

Effect of:

                               

Tax-exempt income

    (15

)

    (20

)

    (52

)

    (60

)

Establish state deferred tax asset

    (33

)

          (1,583

)

     

Non-taxable life insurance income

    (20

)

    (13

)

    (66

)

    (63

)

Restricted stock vesting

                (128

)

    (116

)

Other, net

    8       (2

)

    25       23  

Total

  $ 531     $ 604     $ 43     $ 1,416  

 

Net income before taxes and income tax expense was $2.8 million and $531,000, respectively for the three months ended September 30, 2019, compared with $3.0 million and income tax expense of $604,000, respectively, for the three months ended September 30, 2018.

 

Net income before taxes and income tax expense was $8.8 million and $43,000, respectively for the nine months ended September 30, 2019, compared with $7.8 million and income tax expense of $1.4 million, respectively, for the nine months ended September 30, 2018. Income tax expense for the first nine months of 2019 benefitted $1.6 million from the establishment of a state net deferred tax asset related to the 2019 tax law enactments discussed above. The new laws eliminate the Kentucky bank franchise tax, which is assessed at a rate of 1.1% of average capital, and implements a state income tax for the Bank at a statutory rate of 5%. The new Kentucky income tax will go into effect on January 1, 2021.

 

Analysis of Financial Condition

 

Total assets increased $62.5 million, or 5.8%, to $1.13 billion at September 30, 2019, from $1.07 billion at December 31, 2018. This increase was primarily attributable to an increase in net loans of $38.3 million, as well as an increase in cash and cash equivalents of $22.6 million.

 

 

Loans ReceivableLoans receivable increased $38.3 million, or 5.0%, during the nine months ended September 30, 2019 to $803.6 million as loan growth outpaced paydowns. Our commercial and commercial real estate portfolios increased by an aggregate of $13.2 million, or 2.8% during the first nine months of 2019 and comprised 59.7% of the loan portfolio at September 30, 2019. Within the commercial real estate portfolio, construction loans decreased $20.5 million as several commercial construction projects were completed and sold or migrated to permanent financing. Residential real estate and consumer portfolios increased by an aggregate of $13.5 million, or 5.1% during the first nine months of 2019 and comprised 34.6% of the loan portfolio at September 30, 2019.

 

Loan Portfolio CompositionThe following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in our portfolio and other than the categories noted, there is no concentration of loans in any industry exceeding 10% of total loans.

 

   

As of September 30,

   

As of December 31,

 
   

2019

   

2018

 
   

Amount

   

Percent

   

Amount

   

Percent

 
           

(dollars in thousands)

         

Commercial

  $ 135,981       16.92

%

  $ 129,368       16.91

%

Commercial Real Estate

                               

Construction

    66,351       8.26       86,867       11.35  

Farmland

    82,593       10.28       77,937       10.18  

Nonfarm nonresidential

    194,660       24.22       172,177       22.50  

Residential Real Estate

                               

Multi-family

    59,385       7.39       49,757       6.50  

1-4 Family

    166,412       20.71       175,761       22.97  

Consumer

    52,347       6.51       39,104       5.11  

Agriculture

    45,357       5.64       33,737       4.41  

Other

    483       0.07       536       0.07  

Total loans

  $ 803,569       100.00

%

  $ 765,244       100.00

%

 

 

 

Loan Portfolio by Risk Category – The following table presents a summary of the loan portfolio at the dates indicated, by risk category.

 

    September 30, 2019     December 31, 2018  
   

Loans

   

% to

Total

   

Loans

   

% to

Total

 
   

(dollars in thousands)

 

Pass

  $ 754,050       93.8

%

  $ 745,604       97.4

%

Watch

    37,537       4.7       13,164       1.8  

Special Mention

                113        

Substandard

    11,982       1.5       6,363       0.8  

Doubtful

                       

Total

  $ 803,569       100.0

%

  $ 765,244       100.00

%

 

Loans receivable increased $38.3 million, or 5.0%, during the nine months ended September 30, 2019. Since December 31, 2018, the pass category increased approximately $8.4 million, the watch category increased approximately $24.4 million, and the substandard category increased approximately $5.6 million. The increase in the watch category primarily related to $11.3 million in commercial loans and $8.2 million in agricultural loans migrating to watch during the nine months ended September 30, 2019, and was considered during the evaluation of qualitative trends in the portfolio when establishing the general component of the allowance for loan losses. The $5.6 million increase in loans classified as substandard was primarily driven by $9.7 million in loans moved to substandard, offset by $1.3 million in loans upgraded from substandard, $2.3 million in payments, and $540,000 in charge-offs during the first nine months of 2019.

 

 

Loan Delinquency – The following table presents a summary of loan delinquencies at the dates indicated.

 

   

September 30,

2019

   

December 31,

2018

 
   

(in thousands)

 

Past Due Loans:

               

30-59 Days

  $ 979     $ 1,593  

60-89 Days

    557       331  

90 Days and Over

           

Total Loans Past Due 30-90+ Days

    1,536       1,924  
                 

Nonaccrual Loans

    2,389       1,991  

Total Past Due and Nonaccrual Loans

  $ 3,925     $ 3,915  

 

During the nine months ended September 30, 2019, nonaccrual loans increased by $398,000 to $2.4 million and loans past due 30-59 days decreased from $1.6 million at December 31, 2018 to $979,000 at September 30, 2019. Loans past due 60-89 days increased from $331,000 at December 31, 2018 to $557,000 at September 30, 2019. This represents a $388,000 decrease from December 31, 2018 to September 30, 2019 in loans past due 30-89 days. This trend in delinquency levels is considered during the evaluation of qualitative trends in the portfolio when establishing the general component of the allowance for loan losses.

 

Troubled Debt Restructuring - A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession to a borrower who is experiencing financial difficulty. The Bank’s TDRs may involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired, and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower. If the loan is considered collateral dependent, it is reported net of allocated reserves, at the fair value of the collateral less cost to sell.

 

At September 30, 2019 and December 31, 2018, the Bank had one restructured loan totaling $188,000 and two restructured loans totaling $910,000, respectively, with borrowers who experienced deterioration in financial condition. In general, these loans were granted interest rate reductions to provide cash flow relief to borrowers experiencing cash flow difficulties. The Bank had no restructured loans that had been granted principal payment deferrals until maturity at September 30, 2019 or December 31, 2018. There were no concessions made to forgive principal relative to these loans, although partial charge-offs have been recorded for certain restructured loans. At September 30, 2019, this loan is secured by commercial real estate. All TDRs were performing according to their modified terms at September 30, 2019 and December 31, 2018.

 

There were no modifications granted during 2019 or 2018 that resulted in loans being identified as TDRs. See “Note 3 – Loans,” to the financial statements for additional disclosure related to troubled debt restructuring.

 

Non-Performing AssetsNon-performing assets consist of certain restructured loans for which interest rate or other terms have been renegotiated, loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure and repossessed assets. The following table sets forth information with respect to non-performing assets as of September 30, 2019 and December 31, 2018.

 

   

September 30,

2019

   

December 31,

2018

 
   

(dollars in thousands)

 

Loans on nonaccrual status

  $ 2,389     $ 1,991  

Troubled debt restructurings on accrual

    188       910  

Past due 90 days or more still on accrual

           

Total non-performing loans

    2,577       2,901  

Real estate acquired through foreclosure

    3,225       3,485  

Other repossessed assets

           

Total non-performing assets

  $ 5,802     $ 6,386  
                 

Non-performing loans to total loans

    0.32

%

    0.38

%

Non-performing assets to total assets

    0.51

%

    0.60

%

Allowance for non-performing loans

  $ 28     $ 83  

Allowance for non-performing loans to non-performing loans

    1.09

%

    8.65

%

 

 

Nonperforming loans at September 30, 2019, were $2.6 million, or 0.32% of total loans, compared with $2.9 million, or 0.38% of total loans at December 31, 2018, and $3.6 million, or 0.48% of total loans at September 30, 2018.

 

Allowance for Loan LossesThe allowance for loan losses is based on management’s continuing review and evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require current recognition in estimating loan losses.

 

Management has established loan grading procedures that result in specific allowance allocations for any estimated inherent risk of loss. For loans not individually evaluated, a general allowance allocation is computed using factors developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management’s estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

 

An analysis of changes in the allowance for loan losses and selected ratios for the three and nine month periods ended September 30, 2019 and 2018, and for the year ended December 31, 2018 follows:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

   

December 31,

 
   

2019

   

2018

   

2019

   

2018

    2018  
   

(in thousands)

 

Balance at beginning of period

  $ 8,832     $ 8,580     $ 8,880     $ 8,202     $ 8,202  
                                         

Loans charged-off:

                                       

Real estate

    105       78       237       364       450  

Commercial

    10       50       10       50       50  

Consumer

    184       15       398       49       95  

Agriculture

                4       12       13  

Other

                      8       8  

Total charge-offs

    299       143       649       483       616  
                                         

Recoveries

                                       

Real estate

    352       526       499       1,076       1,437  

Commercial

    6       10       101       255       261  

Consumer

    9       9       69       59       69  

Agriculture

    3       2       3       13       15  

Other

    1             1       12       12  

Total recoveries

    371       547       673       1,415       1,794  

Net charge-offs (recoveries)

    (72

)

    (404

)

    (24

)

    (932

)

    (1,178

)

Provision (negative provision) for loan losses

          (350

)

          (500

)

    (500

)

Balance at end of period

  $ 8,904     $ 8,634     $ 8,904     $ 8,634     $ 8,880  
                                         

Allowance for loan losses to period-end loans

    1.11

%

    1.14

%

    1.11

%

    1.14

%

    1.16

%

Net charge-offs (recoveries) to average loans     (0.04 )%     (0.21 )%     0.00 %     (0.17 )%     (0.16 )%

Allowance for loan losses to non-performing loans

    345.52

%

    239.70

%

    345.52

%

    239.70

%

    306.10

%

 

The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The allowance for loan losses is comprised of general reserves and specific reserves. The loan loss reserve, as a percentage of total loans at September 30, 2019, decreased to 1.11% from 1.16% at December 31, 2018 and from 1.14% at September 30, 2018. New loans continue to be underwritten with lower loss expectations. Historical loss experience, risk grade classification metrics, charge-off levels, and past due trends remain at historically strong levels and were generally stable between periods. The allowance for loan losses to non-performing loans was 345.52% at September 30, 2019, compared with 306.10% at December 31, 2018, and 239.70% at September 30, 2018. Net loan recoveries in the first nine months of 2019 totaled $24,000 compared to net recoveries of $932,000 in the first nine months of 2018.      

 

The majority of nonperforming loans are secured by real estate collateral, and the underlying collateral coverage for nonperforming loans supports the likelihood of collection of principal. Management has assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable incurred losses. The allowance for loan losses to non-performing loans and TDRs on accrual was 345.52% at September 30, 2019 compared with 306.10% at December 31, 2018, and 239.70% at September 30, 2018. The increase in this ratio from December 31, 2018 to September 30, 2019 was primarily attributable to trends in non-performing loans during the period.

 

 

Based on prior charge-offs, the current recorded investment in loans individually evaluated for impairment in the commercial real estate and residential real estate segments of the portfolio are significantly below the unpaid principal balance for those loans. The recorded investment net of the allocated allowance was 52.35% and 65.85% of the unpaid principal balance in the commercial real estate and residential real estate segments of the portfolio, respectively, at September 30, 2019.

 

Provision for Loan Losses Based upon historically strong trends in asset quality and management’s assessment of risk in the loan portfolio, no provision for loan losses was recorded for the third quarter or the first nine months of 2019. A negative provision for loan losses of $350,000 and $500,000 was recorded for the third quarter and the first nine months of 2018, respectively. The pass category increased approximately $8.4 million, the watch category increased approximately $24.4 million, and the substandard category increased approximately $5.6 million. Net loan recoveries were $24,000 for the nine months ended September 30, 2019, compared with net recoveries of $932,000 for the nine months ended September 30, 2018. Management considers the size and volume of our portfolio as well as the credit quality of the loan portfolio based upon risk category classification when determining the loan loss provision for each period and the allowance for loan losses at period end.

 

Foreclosed Properties – Foreclosed properties at September 30, 2019 were $3.2 million compared with $3.8 million at September 30, 2018 and $3.5 million at December 31, 2018. See Note 4 – “Other Real Estate Owned,” to the financial statements. Management values foreclosed properties at fair value less estimated costs to sell when acquired and expects to liquidate these properties to recover the investment in the due course of business.

 

OREO is recorded at fair market value less estimated cost to sell at time of acquisition. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. When foreclosed properties are acquired, management obtains a new appraisal or has staff from the Bank’s special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Management typically obtains updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a listing price is lowered below the appraisal amount.

 

Write-downs and operating expenses for OREO totaled $333,000 for the nine months ended September 30, 2019, compared to net gain (loss) on sales, write-downs, and operating expenses of $590,000 for the nine months ending September 30, 2018. During the nine months ended September 30, 2019, fair value write-downs of $260,000 were recorded due to changing marketing strategies compared with write-downs of $585,000 for the nine months ended September 30, 2018.

 

LiabilitiesTotal liabilities at September 30, 2019 were $1.0 billion compared with $977.6 million at December 31, 2018, an increase of $50.2 million, or 5.1%. This increase was primarily attributable to an increase in deposits of $29.2 million and the issuance of the $17.0 million subordinated capital note.

 

Deposits are the Bank’s primary source of funds. The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:

 

   

For the Nine Months

   

For the Year

 
   

Ended September 30,

   

Ended December 31,

 
   

2019

   

2018

 
   

Average

   

Average

   

Average

   

Average

 
   

Balance

   

Rate

   

Balance

   

Rate

 
   

(dollars in thousands)

 

Demand

  $ 143,577             $ 136,947          

Interest checking

    97,462       0.28

%

    90,583       0.13

%

Money market

    163,440       1.12       158,832       0.90  

Savings

    33,829       0.17       34,866       0.16  

Certificates of deposit

    482,181       1.95       439,597       1.35  

Total deposits

  $ 920,489       1.26

%

  $ 860,825       0.88

%

 

 

The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:

 

   

For the Nine Months

   

For the Year

 
   

Ended September 30,

   

Ended December 31,

 
   

2019

   

2018

 
   

Average

   

Average

   

Average

   

Average

 
   

Balance

   

Rate

   

Balance

   

Rate

 
   

(dollars in thousands)

 

Less than $250,000

  $ 453,421       1.94

%

  $ 410,942       1.34

%

$250,000 or more

    28,760       2.14

%

    28,655       1.51

%

Total deposits

  $ 482,181       1.95

%

  $ 439,597       1.35

%

 

 

The following table shows at September 30, 2019 the amount of our time deposits of $250,000 or more by time remaining until maturity (in thousands):

  

Maturity Period

 
         

Three months or less

  $ 4,163  

Three months through six months

    11,714  

Six months through twelve months

    7,922  

Over twelve months

    3,778  

Total

  $ 27,577  

 

Liquidity

 

Liquidity risk arises from the possibility the Company may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure that we meet the cash flow requirements of depositors and borrowers, as well as operating cash needs, taking into account all on- and off-balance sheet funding demands. Liquidity risk management also involves ensuring that cash flow needs are met at a reasonable cost. Management maintains an investment and funds management policy, which identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements in compliance with regulatory guidance. The Asset Liability Committee regularly monitors and reviews our liquidity position.

 

Funds are available to the Bank from a number of sources, including the sale of securities in the available for sale investment portfolio, principal pay-downs on loans and mortgage-backed securities, customer deposit inflows, and other wholesale funding.

 

The Bank also borrows from the FHLB to supplement funding requirements. At September 30, 2019, the Bank had an unused borrowing capacity with the FHLB of $30.7 million. Advances are collateralized by first mortgage residential loans and borrowing capacity is based on the underlying book value of eligible pledged loans.

 

The Bank also has available on an unsecured basis federal funds borrowing lines from a correspondent bank totaling $5.0 million. Management believes the sources of liquidity are adequate to meet expected cash needs for the foreseeable future. The Bank has also in the past utilized brokered and wholesale deposits to supplement its funding strategy. At September 30, 2019, the Bank had no brokered deposits.

 

The Company uses cash on hand to service senior debt, subordinated debt, and to provide for operating cash flow needs. The Company also may issue common equity, preferred equity and debt to support cash flow needs and liquidity requirements. At September 30, 2019, cash on hand totaled $5.2 million, of which, $146,000 is held in escrow by the Company’s senior debt holder to service interest payments.

 

Capital

 

Stockholders’ equity increased $12.2 million to $104.3 million at September 30, 2019, compared with $92.1 million at December 31, 2018 primarily due to current year net income of $8.8 million and other comprehensive income for the first nine months of 2019 of $3.4 million.

 

The following table shows the ratios of Tier 1 capital, common equity Tier 1 capital, and total capital to risk-adjusted assets and the leverage ratios (excluding the capital conservation buffer) for the Bank at the dates indicated:

 

   

Regulatory

Minimums

   

Well-Capitalized

Minimums

   

September 30, 2019

   

December 31, 2018

 
                                 

Tier 1 Capital

    6.0 %     8.0 %     13.87 %     11.83 %

Common equity Tier 1 capital

    4.5       6.5       13.87       11.83  

Total risk-based capital

    8.0       10.0       14.89       12.88  

Tier 1 leverage ratio

    4.0       5.0       11.25       9.60  

 

 

The Company’s capital ratios were positively impacted by the $17.0 million of subordinated notes issued during the third quarter, as the subordinated notes meet the requirements to qualify as Tier 2 capital. The Bank’s capital ratios also benefitted as the Company contributed $10.0 million of the proceeds to the Bank as Common Equity Tier 1 Capital.

 

Failure to meet minimum capital requirements could result in discretionary actions by regulators that, if taken, could have a materially adverse effect on our financial condition.

 

 

Each of the federal bank regulatory agencies has established risk-based capital requirements for banking organizations. The Basel III regulatory capital reforms became effective for the Company and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. These rules refine the definition of what constitutes “capital” for purposes of calculating those ratios, including the definitions of Tier 1 capital and Tier 2 capital. The final rules allow banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5%, to be phased in over three years, above the regulatory minimum risk-based capital ratios. With the capital conservation buffer as fully phased in effective January 1, 2019, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total capital to total risk-weighted assets (“total risk-based capital ratio”) of 10.5%. The capital conservation buffer for 2019 is 2.50% and was 1.875% for 2018. An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Given an instantaneous 100 basis point increase in interest rates, the base net interest income would decrease by an estimated 0.7% at September 30, 2019, compared with an increase of 2.0% at December 31, 2018. Given a 200 basis point increase in interest rates, base net interest income would decrease by an estimated 1.8% at September 30, 2019, compared with an increase of 3.9% at December 31, 2018.

 

The following table indicates the estimated impact on net interest income under various interest rate scenarios for the twelve months following September 30, 2019, as calculated using the static shock model approach:

 

   

Change in Future

Net Interest Income

 
   

Dollar Change

   

Percentage

Change

 
   

(dollars in thousands)

 

+ 200 basis points

  $ (636 )     (1.82

)%

+ 100 basis points

    (252 )     (0.72 )

- 100 basis points

    (279

)

    (0.80

)

- 200 basis points

    (530

)

    (1.52

)

 

Item 4. Controls and Procedures

 

As of the end of the quarterly period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)). Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were, to the best of their knowledge, effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms as of such date.

 

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

 

In the normal course of business, the Company and its subsidiaries have been named, from time to time, as defendants in various legal actions. Certain of the actual or threatened legal actions may include claims for substantial compensatory and/or punitive damages or claims for indeterminate amount of damages. Litigation is subject to inherent uncertainties and unfavorable outcomes could occur.

 

The Company contests liability and/or the amount of damages as appropriate in each pending matter. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in the early stages, the Company cannot predict with certainty the loss or range of loss, if any, related to such matters, how or if such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, or other relief, if any, might be. Subject to the foregoing, the Company believes, based on current knowledge and after consultation with counsel, that the outcome of such pending matters will not have a material adverse effect on the consolidated financial condition of the Company, although the outcome of such matters could be material to the Company’s operating results and cash flows for a particular future period, depending on, among other things, the level of the Company’s revenues or income for such period. The Company will accrue for a loss contingency if (1) it is probable that a future event will occur and confirm the loss and (2) the amount of the loss can be reasonably estimated.

 

The Company is not currently involved in any material litigation.

 

Item 1A. Risk Factors

 

Refer to the detailed cautionary statements and discussion of risks that affect the Company and its business in “Item 1A – Risk Factors” of the Annual Report on Form 10-K, for the year ended December 31, 2018. There have been no material changes from the risk factors previously discussed in those reports.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Not applicable.

 

Item 3. Default Upon Senior Securities

 

Not applicable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

Not applicable

 

 

Item 6. Exhibits

 

 

(a)

Exhibits

 

The following exhibits are filed or furnished as part of this report:

 

Exhibit Number

Description of Exhibit

  

2.1*

Branch Purchase and Assumption Agreement between Republic Bank & Trust Company and Limestone Bank, Inc. dated July 24, 2019. Exhibit 2.1 to Form 8-K filed July 25, 2019 is incorporated by reference.

   

3.1

Articles of Incorporation of the Company, restated to reflect amendments. Filed as Exhibit 3.1 to the Quarterly Report on Form 10-Q filed August 2, 2019 and incorporated by reference.

   

3.2

Amended and Restated Bylaws of Limestone Bancorp, Inc. dated June 18, 2018. Exhibit 3.2 to Form 8-K filed June 6, 2018 is hereby incorporated by reference.

   

4.1

Tax Benefits Preservation Plan, dated as of June 25, 2015, between the Company and American Stock Transfer Company, as Rights Agent. Exhibit 3.1 to Form 8-K filed June 29, 2015 is incorporated by reference.

   

4.2

Amendment No. 1 to the Tax Benefits Preservation Plan, dated August 4, 2015. Exhibit 4.2 to the Quarterly Report on Form 10-Q filed August 5, 2015 is incorporated by reference.

   

4.3*

Amendment No. 2 to the Tax Benefits Preservation Plan dated May 23, 2018. Exhibit 4 to the Form 8-K filed May 23, 2018 is incorporated by reference.

   

4.4

Indenture, dated July 23, 2019, by and between Limestone Bancorp, Inc. and Wilmington Trust National Association, as trustee. Exhibit 4.1 to Form 8-K filed July 25, 2019 is incorporated by reference.

   

4.5

Form of 5.75% Fixed-to-Floating Subordinated Notes due 2029 of Limestone Bancorp, Inc. Exhibit 4.2 to Form 8-K filed July 25, 2019 is incorporated by reference.

   

10.1

Form of Subordinated Note Purchase Agreement, dated July 23, 2019, by and among Limestone Bancorp, Inc. and the Purchasers. Exhibit 10.1 to Form 8-K filed July 25, 2019 is incorporated by reference.

   

31.1

Certification of Principal Executive Officer, pursuant to Rule 13a - 14(a)

   
31.2 Certification of Principal Financial Officer, pursuant to Rule 13a - 14(a).
   

32.1

Certification of Principal Executive Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

   

32.2

Certification of Principal Financial Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

101

The following financial statements from the Company’s Quarterly Report on Form 10Q for the quarter ended September 30, 2019, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statement of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements.

   

*

Schedules and similar attachments to the Purchase and Assumption Agreement have been omitted pursuant to Item 601(a)(5) of Regulation S-K. A copy of any omitted schedule or similar attachment will be furnished to the Securities and Exchange Commission upon request.

 

The Company has other long-term debt agreements that meet the exclusion set forth in Section 601 (b)(4)(iii)(A) of Regulation S-K. The Company hereby agrees to furnish a copy of such agreements to the Securities and Exchange Commission upon request.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act if 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

  

LIMESTONE BANCORP, INC.

  

(Registrant)

  

November 1, 2019

  By:

/s/ John T. Taylor

  

  

John T. Taylor

  

  

Chief Executive Officer 

  

November 1, 2019

  By:

/s/ Phillip W. Barnhouse

 

 

Phillip W. Barnhouse 

  

  

Chief Financial Officer

  

  

 

 

50